The Brazilian economy is heading for “deterioration” with low growth and high inflation at home and a challenging external environment, a respected former central bank governor warned in a strongly-worded attack on the current administration.
“We are living through a moment of great frustration and great danger,” Arminio Fraga said. “Looking forward, things may get worse. It may have consequences on inflation, it may become more serious in terms of growth.
“It is not really the current picture that bothers me, but indeed the film – it is a film of deterioration and frustration,” said Fraga, who is now advising the main opposition candidate Aécio Neves on economic matters.
Furthermore, Brazil has been registering a current account deficit of over 3.5% of GDP. “Brazil will have to finance this internationally at a time when international liquidity may fall quite a bit. The China slowdown may also hurt us, this would hamper exports, all of this may squeeze us,” Fraga told Emerging Markets. “If we get to this point with a relatively large current account deficit, the impact will be even greater.”
Fraga also said Brazil is ill-prepared for an eventual hike in US interest rates. “It is not possible to avoid the impact of such an event, so Brazil has to prepare for it, it has to recover its credibility in terms of macroeconomic policies. The impact cannot be totally avoided, but it can be softened.”
Brazilian officials have been bolstered by the market reaction in the aftermath of this week’s Standard & Poor’s downgrade, but their policy record has continued to be questioned. Critics have stopped short of predicting an immediate collapse of the Brazilian economy or a sudden stop of capital flows in the light of the new US monetary policy, but they say warning signs have already been flagged.
POOR QUALITY
The Institute of International Finance haspointed at “policy inconsistencies” that led to a mix of low economic growth, high inflation against a background of low productivity. The central bank now forecasts economic growth to reach 2% this year, following 2.3% last year, according to its quarterly report issued yesterday, while inflation is expected to reach 6.1%.
“Policies are of poor quality. But the government seems to be ignoring the warnings. If they continue the way they do, the situation [is] not going to be stable,” said John Welch, emerging market macro strategist at CIBC in Vancouver.
The government has pledged to restore fiscal discipline during an election year in order to alleviate investors’ fear and boost Dilma Rousseff’s chances of re-election. In order to restore credibility, Brazilian officials have said they will pursue a primary surplus target of 1.9% of GDP in 2014. But in February, the central government actually registered a primary fiscal deficit of over R$3bn, is the worst performance in five years.
Nevertheless, Standard & Poor’s, which downgraded Brazil’s sovereign ratings this week, said they did not expect greater fiscal damage. However Sebastian Briozzo, senior director at S&P said Brazil had “very little room of manoeuvre to face an external shock”.