BRAZIL: Caution to the wind

Brazilian president-elect Dilma Rousseff has signaled the administration will maintain a lid on public spending. But without urgent fiscal tightening, inflation and the current account gap could spiral out of control

  • By Thierry Ogier
  • 08 Oct 2010
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The economic boom that has buttressed outgoing president’s Lula da Silva’s popularity now comes at a cost: inflation, currency appreciation and a widening current account deficit. From day one, president-elect Dilma Rousseff will face an uphill battle, as she juggles economic realities with development goals.

Below follows an in-depth feature on Brazil’s macro-economic challenges, published before the outcome of the October presidential election. 


Henrique Meirelles, the longest serving central bank president in Brazilian history, reckons the Brazilian economy looks “unassailable”.

Certainly some of the numbers look good. Economic growth of around 7% this year is not to be sniffed at. Brazil’s finance minister Guido Mantega is already talking about “laying the ground for a welfare state”.

Brazil’s policy-makers are confident their country is now ready to join the Premier League – and little can derail their optimism over growth.

Yet, not all is rosy. Following five years of surplus since 2003, the current account gap has been widening and is fast approaching 3% of GDP (up from 1.5% of GDP last year). Moreover, foreign direct investment, which reached record levels in 2008 at $45 billion, has declined and will not be able to finance the deficit any longer.

Ricardo Hausmann, director of the Center for International Development and a professor at Harvard University, suspects Brazilian policy-makers of complacency in the face of more difficult economic data, including a rising current account deficit.

“I don’t have a problem with the current account worsening per se,” he tells Emerging Markets. “But it is indicative that the current rate of economic growth is higher than the rate of growth that you could sustain in the long run.

“You should not plan as if this was the level of the long-term rate of growth...elections are excellent times to create artificial booms.”

Marcelo Carvalho, chief economist at BNP Paribas in Sao Paulo, says: “Brazil will have to rely more on portfolio investment and short-term capital flows, which can prove to be volatile.”

Most economists forecast that the deficit will worsen in coming years. “This is not yet dangerous, but these things aren’t an issue until they become an issue. The trend is certainly something to watch,” says Carvalho.

Finance minister Guido Mantega reckons that this trend is not a lasting one and will be reversed. “We will continue to register a current account deficit over the next two years, but there will be a global recovery from 2012, and Brazil will then be able to increase its exports,” he says.

“We are prepared for any kind of scenario, even a double-dip recession, despite the fact that it is not the most likely scenario,” Meirelles tells Emerging Markets.

He also rejects any suggestion of renewed vulnerability – out of hand: “It is not a vulnerability... No, it is not a dependency [on short-term capital flows]. If for some reason at some point, the market thinks the level of deficit is not sustainable, there will be an adjustment in the foreign exchange rate.

“The most important role of the free-floating exchange rate regime is to balance the external accounts in the long run.”

Meirelles believes the combination of strong reserves and a free-floating exchange rate will ensure such a readjustment would not be chaotic. “We have sufficient reserves to make sure that any adjustment is done in time, orderly, without a reason for any kind of crisis as in 2008, for example,” he says.


In the height of the global financial crisis, the Brazilian real sank on the foreign exchange market at the end of 2008, during what Meirelles called “the most important foreign exchange crisis since 1929”, but later bounced back (the government even introduced a tax on foreign investment to stem the currency appreciation at the end of 2009).

“The greatest pressure on the current account comes from profits and remittances – $32 billion. This is due to the difficult situation of foreign companies to correct their balance sheets. They are also taking advantage of a favourable exchange rate, which will not remain as favourable,” says Mantega. “There will naturally be some exchange rate depreciation in the future because interest rates will continue to fall, and there will be less space for carry trade. This is an issue that the next government will have to take great care with.”

The view is shared to some degree by the central bank. “Are we worried about a foreign exchange crisis as we had in the past?” says Meirelles. “The answer is no. There used to be two reasons for foreign exchange crises over the past decades: one is a controlled, managed foreign exchange rate. When market conditions change, when central banks spend reserves to defend a specific exchange rate, as happened in many countries throughout history, at some point you may have a crisis.

“The other reason is low reserves, even when a country has a free-floating foreign exchange market. Why? If for some reason risk aversion goes up, there is a run for exit [flight to safety]. If you do not have enough reserves, you might have a liquidity squeeze.

“Both problems happened in the past. Today we have a free-floating exchange rate regime... and we have a comfortable level of international reserves, which enabled, for instance, Brazil to face successfully the most important foreign exchange crisis since 1929, which was the crisis in the last quarter of 2008,” says Meirelles.

Brazil was able to act as a lender of last resort in dollars to the Brazilian banking system, to exporters and other corporations because we had sufficient level of reserves.”


The big economic issues were largely ignored during the recent electoral campaign – an irony given the two prime candidates in the presidential race are trained economists.

Lula’s protege, Dilma Rousseff, has sought to minimize the risks of a growing current account deficit. She insists the increase in imports of capital goods and machinery will eventually benefit productivity.

José Serra, the opposition presidential candidate, would have none of this. “It’s obvious that this is not the case,” says Serra, who has warned against the risk of de-industrialization and the increasing dependence on volatile commodity export prices. “We are importing consumer goods.” In some parts of the economy this is already apparent – Brazil, for example, is importing fewer cars than it exports. And the trade surplus has been narrowing rapidly in recent years.

Serra, who has long opposed the notion of central bank independence, has questioned the consensual economic policy “tripod” (a mix of primary fiscal surplus, inflation targets and free-floating exchange rate), which has been in vogue in Brazil in recent years.

Moreover, he has lashed out at what he calls the “perverse tripod”, saying “we have the highest tax burden among developing countries, the highest real interest rates, and the lowest rate of public-sector investment in the world.”

Local economists, such as BNP Paribas’ Carvalho, point out that Brazil still needs structural changes, such as social security reform, to boost the low level of domestic savings.

Nilson Teixeira, Credit Suisse’s chief economist in Sao Paulo, also emphasizes the importance of a boost in domestic savings.”

“If these dynamics [an increase in domestic savings and the investment rate] are not confirmed, the risk of Brazil’s external accounts not being sustainable would increase. In this negative scenario, the costs of financing the deficit would increase, leading to stronger economic slowdown and greater local currency depreciation,” the report said.

Nevertheless, Teixeira rules out any major risk. “We believe that an increase in the current account deficit in Brazil to levels near 5.5% of GDP in 2015, in a scenario of moderate global growth and low risk of fiscal insolvency, would not trigger an interruption in the cycle of strong economic growth in the country,” he said.

“The risks of a reversal of economic growth in connection with a balance of payments crisis are low. This view is due to the high level of international reserves and the important changes in the composition of the current account balance and external liabilities in recent years.” (These include a reduction in external debt and an increase in liabilities denominated in domestic currency, such as fixed-income securities in the domestic market.)


When Lula took office in 2003, the economic situation was so fragile that he had little margin to manoeuvre and no choice but to stick to the orthodox policies implemented by his predecessor. Mohamed el Erian, the global fixed-income investor, recently mentioned that a Wall Street bank actually recommended him to sell the Brazilian bonds Pimco has bought in the midst of the confidence crisis.

Now that Lula is about to bow out in style, most political observers say Brazil’s economic record looks so strong that his successor may have little option but to keep to the same policies.

“There is little room to change,” says Meirelles. “Today the working class knows very well the value of low inflation, and the way there has been an increase in purchasing power for the average worker in recent years. There is strong political support for this economic model.”

Nevertheless, things could go wrong when the new government is sworn in at the beginning of next year. “That probability is low,” says Meirelles. “That’s because of the number of Brazilians who took advantage of these economic achievements – 31 million Brazilians became part of the middle class and 19 million crossed the poverty line. Formal jobs have been created at record levels: 1.5 million new jobs during recent years, maybe 2 million this year.

“All of that gives political support to these economic policies,” he says.

  • By Thierry Ogier
  • 08 Oct 2010

All International Bonds

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1 Citi 253,106.92 930 8.89%
2 JPMorgan 230,914.50 1036 8.11%
3 Bank of America Merrill Lynch 221,389.46 762 7.78%
4 Goldman Sachs 171,499.26 554 6.03%
5 Barclays 169,046.60 646 5.94%

Bookrunners of All Syndicated Loans EMEA

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1 HSBC 25,935.16 104 7.16%
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3 Bank of America Merrill Lynch 22,023.57 59 6.08%
4 BNP Paribas 19,315.94 110 5.34%
5 Credit Agricole CIB 18,706.93 106 5.17%

Bookrunners of all EMEA ECM Issuance

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1 JPMorgan 12,578.87 55 8.17%
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3 UBS 10,682.06 44 6.93%
4 Goldman Sachs 10,419.53 53 6.76%
5 Morgan Stanley 10,194.88 57 6.62%