While many countries in Latin America have been watched with envy by other emerging states across the world for their fast growth and falling inflation, the continent’s biggest economy has provoked concern. Anaemic growth and high inflation would be a toxic combination for any economy, let alone a key emerging one such as Brazil. But this is what happened in 2012.
Government officials are now betting on private-sector involvement in infrastructure investment to improve the country’s competitiveness and re-launch economic growth. They have tried this before, with varying degrees of success, but now it seems they understand they have to try harder. “There is a clear determination from the federal government that this has to happen. There is a clear vision that investment in infrastructure is the key to boosting productivity and competitiveness in the whole economy,” a government source tells Emerging Markets.
Officials have been touring the world again to convince investors that Brazil is a safe bet and that returns will materialize. The current transport and energy package involves some 400 billion reais ($200 billion) including roads, railways, ports and airports. Some of the main international airports have already been auctioned off, and others are due to follow by the end the year, including in Rio de Janeiro. It is not only a matter of expanding capacity, but also of making operations more efficient, as the eyes of the world are on next year’s football World Cup and the 2016 Rio Olympics.
After years of boosting credit and domestic consumption, the government has turned its attention to the supply side of the economy. Finance minister Guido Mantega is confident that much-needed productivity improvement will occur. “Once you improve the supply side of services, progress will be achieved. At the moment, when you have to unload a container at the port, sometimes the ship has to remain three, four or up to six days; this will be reduced to a single day. So you will have a better offer of services to handle cargo from Mato Grosso to São Paulo, for instance. Productivity will increase overall,” Mantega tells Emerging Markets.
But in more cases than one, the productivity train has been running late in Brazil in the past decades, hence the lack of competitiveness of large parts of its industry, regardless of exchange rate factors. The current investment programme in logistics, known as PIL, has not come without hiccup: two planned road concessions in the south-eastern state of Minas Gerais had to be rescheduled at the beginning of the year as investors said that the proposed returns on investment were not attractive enough. The government backed down and presented more favourable conditions.
As a result of the government’s indecision on public works concessions, Brazil is still lagging behind in terms of global productivity. According to a survey by the Boston Consulting Group (BCG), productivity has not been a key driver of economic growth in the largest Latin American economy. Productivity gains in Brazil accounted for just a quarter of its average economic growth (of 3.7%) between 2001 and 2011. By comparison, in South Korea productivity increase accounted for 72% of growth – not to mention China, where it represented 93%. In Brazil, almost half of productivity gains were achieved thanks to commodity related sectors. “In recent years, Brazil has registered fewer productivity gains than other emerging markets. The opportunity we see now is to have a greater focus on productivity to support economic growth in the next 10 years,” says Masao Ukon, a BCG partner in São Paulo. The current emphasis on the supply side and infrastructure is viewed as a positive sign. Adds Julio Bezerra, director of BCG: “It is extremely positive that the country is moving in that direction.”
SORE POINT
But some feel there are still big question marks regarding the macroeconomic policy. Inflation is a sore point. Even if economic activity was subdued last year, the benchmark consumer price index ended 2012 at 5.8%, well above the centre of the official inflation target (4.5%). In 2011, inflation hit 6.5%, which is the maximum that is allowed under Brazil’s current inflation targeting regime. In the meantime, the central bank slashed its benchmark Selic rate by 525 basis points to 7.25%.
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For the first time in January, the central bank’s president, Alexandre Tombini, expressed “some discomfort”. Now, inflation is expected to accelerate again, at least during the first half of the year. Investors feel uncomfortable, too. “Brazil is one of the very few countries in the world these days where people are still worried about inflation,” says Phil Suttle, chief economist of the Institute of International Finance (IIF). “The fact that they have got such low interest rates by Brazilian standards with inflation accelerating seems to be worrying people. If you are in the business community, this is presumably a kind of threat that hangs over you.”
Brazilian policymakers have adopted a very different stance than some of their Latin American counterparts, such as Peru and Chile, who would rather react well ahead of the curve when it comes to monetary policy. Slashing interest rates was a political commitment from President Dilma Rousseff, but the situation has now become so critical that Mantega recently admitted that some monetary tightening could not be ruled out.
Government officials reckon that food prices are the main culprit for the inflation bout, but statistics point to widespread price increases, including in services.
While the government says it has a strong focus on resuming economic growth, its message seems to be blurred by apparently antagonistic measures. Last year, central bank interventions led to a depreciation of the Brazilian real by 16% against the US dollar in an effort to boost industry competitiveness; but in the first weeks of 2013, such policy was reversed and the dollar plunged again below the 2 Brazilian real mark.
The government has strongly denied the policy reversal was motivated by inflation concern. Its stated intention was to avoid exchange rate volatility – but investors say that the government has in fact fanned such volatility. In the same vein, the government has acted to slash electricity rates on the one hand and allowed a fuel price increase on the other. Still wary about inflation, finance ministry officials asked recently-elected mayors in large cities, including São Paulo, to delay bus fare increases.
On the fiscal front, the government used measures such as excluding some public investment from its accounts to meet its closely-watched primary surplus target (of 3.1% of GDP) on paper last year. And as debt servicing costs declined thanks to interest rate cuts, the overall nominal public deficit fell slightly to less than 2.5% of GDP.
WIDENING PROBLEM
Nevertheless, the debt volume has increased (to 2.01 trillion reais in 2012, + 7% in one year) and the gap between the net and the gross debt has widened. While the former fell to 35.1% of GDP last year, the latter stood at 58.6% of GDP (up 4.4 percentage points compared to 2011). In 2006 the difference between the two was less than 10 percentage points. Most of the change, the government says, is related to the increase in international reserves, which now stand at around $375 billion, or more than double the 2008 amount.
The gross public debt represents the cumulative total of all government borrowings minus repayments that are denominated in Brazilian currency. Net debt is the country’s total debt minus international reserves and other government money.
André Esteves, CEO of BTG Pactual, the investment bank, has endorsed the official argument. He has also minimized criticisms against the repeated transfers from the Treasury to the social development bank, BNDES, which is also trying to boost investment in the Brazilian economy. “The BNDES has been presenting a consistent performance and has been profitable in the last five years. The money is not going to disappear,” he says.
Esteves also reckons that “the net debt figure can be considered a proxy of fiscal strength.” At current level, it is “the best of the G20”, he says.
Paulo Valle, deputy debt manager at the finance ministry, told Emerging Markets that the medium-term policy is to curb both levels of net and gross public debt. “The trend is towards a decline. The net debt to GDP ratio will be below 30% in four years, and the gross debt will be below 45% of GDP,” he says.
A MATTER OF EXPECTATIONS
While Mantega says that “what is lacking is to win the battle of expectations”, critics say that market expectations have been confused by recent policy activism, which has left a bad taste of improvization. “Such economic policy regime is inconsistent. You can’t fight inflation by asking mayors to postpone fare increases or causing the exchange rate to appreciate,” says Samuel Pessôa, an academic from the Getulio Vargas Foundation, a Rio-based business school.
The orthodox policy mix in Brazil has been based on a transparent fiscal policy, inflation targeting and a floating exchange rate in the past, he says. “But the macroeconomic policy framework has been dismantled. This has reduced the visibility for business. It is one of the reasons why investment has been falling,” he says.
Ramón Aracena, chief Latin American economist at the IIF, says that this may reduce the capacity of executives to plan their business. “[Government officials] are trying to achieve too many objectives simultaneously. This creates some confusion in the mind of the private sector,” he says.
But after more than 10 years in power, the left-wing government led by the Workers’ Party is increasingly shrugging off critics while implementing its political agenda. “The policy framework is essentially the same, but there is an agenda of transformation” on the whole economy, says a government official. He insists that business confidence is already coming back. “There was a cut in inventories in the second half of last year. We did suffer. But the situation has since been normalized. Some investors are enthusiastic, such as in the automotive sector, the chemical and petrochemical industry, or textile,” the official, who did not want to be named, told Emerging Markets.
A lot is at stake. President Rousseff was elected to succeed Luiz Inacio Lula da Silva thanks to her reputation as an efficient manager who could fix the country’s inefficient infrastructure. Her popularity is still at a record high after more than two years in office, mainly thanks to a record low level of unemployment (5.5% last year) and to social policies. But if she fails to deliver on infrastructure and on the economic growth front, the tide may well turn. Should this happen, she will face an uphill struggle at next year’s presidential election.
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