Some jokes do not turn out to be that funny. When former president Luiz Inácio da Silva called Dilma Rousseff “the PAC’s mother”, in a reference to Brazil’s flagship programme to accelerate growth during the previous electoral campaign four years ago, this turned out to be a huge boost. But since Rousseff took office three years ago, economic growth has limped along at 2% on average.
The outlook for this year is not bright either. Assuming there will be any acceleration at all, it is bound to remain modest – not the kind of “spectacular growth” that Lula had once promised. Indeed, Rousseff is expected to end her term with the lowest growth average since Fernando Collor de Mello, the president who started opening up the Brazilian economy but is mostly remembered for freezing the savings of the population in the early 1990s.
Now, after 10 years of Workers’ party governments in power, it is the development model that is increasingly put into question.
This has not been an easy ride for Rousseff. Some of her policy goals have been frustrated. The main one was to cut bank spreads aggressively and to bring real base rates down towards 2%. This would favour the local industry and discourage financial speculation, she argued. But the central bank, which slashed its base rates in 2012, started to backpedal last year after it became clear that supply bottlenecks were feeding price increases. The effect on inflation has been disheartening: the benchmark consumer price index has flirted with 6% for the past three years – hitting the top range of Brazil’s inflation target at 6.5% in 2011. Real interest rates are now well over 4%. Nominal base rates, ironically, are now back at the level they were when Rousseff took office in January 2011 (10.75%).
HANGOVER SETS IN
Moreover, the world has changed, and large commodity exporters such as Brazil have to find new engines of growth. Years of bonanza allowed the financing of social policies, strengthening the middle class, which together with cheap credit helped boost the domestic market. Now, however, the party is over.
“The China slowdown means that the commodity super-cycle is well behind us,” says Marcelo Carvalho, Latin America chief economist at BNP Paribas in São Paulo. “The five year outlook is now negative rather than positive. Commodity prices have stopped increasing and China is growing less; it has become more difficult to balance the external accounts. Domestic consumption is growing faster than the country’s supply.”
The current account deficit has increased to 3.7% of GDP, from 2.4% in 2012. Strong foreign direct investor flows ($65bn) cannot fill the $80bn gap on their own anymore. Last but not least, the US tapering announcement has sent a shockwave through global capital markets, and the Brazilian currency may come under renewed pressure.
Brazilian officials are unrepentant: they insist that household consumption had been growing for the 10th consecutive year in 2013, although at a more modest pace than previously (2.3%, in line with GDP growth). “This was possible thanks to the increase in the wage mass and consumer credit,” according to the Brazilian statistics institute (IBGE). Moreover, the country still has near full employment.
The gap between supply and demand, however, together with persisting supply bottlenecks and low productivity, has also put pressure on prices. “This is why the central bank has been raising its base rates to contain inflation as consumption is growing faster than supply,” says Carvalho.
The tightening cycle, which started last April, now amounts to 350bp. “There are adjustments to be made,” says Tony Volpon, Latin America strategist at Nomura Securities in New York. “The central bank has been very responsible by raising interest rates... The question is: how is the economy going to return to a more robust growth path?
“Brazil has had pretty disappointing growth since 2011; now we are talking about four or five years of 2% growth. Is this the new model for Brazil? Are we just condemned to another 10 years of mediocrity, which would have all sorts of consequences – political, social and, of course, for investors?” he asks.
BUILDING UP BRAZIL
The government says it has got the message. The new focus is on investment and partnerships with the private sector in infrastructure. “We have been growing our own investments, and we have launched a large infrastructure programme together with the private sector, which [will] result in a high level of investments over the coming years,” says finance minister Guido Mantega. True, gross fixed investment grew by 6.3% last year in annual terms, but it remains low at 18.4% of GDP (indeed, below the original development bank BNDES’ forecast of 19.2%, and even lower than the Latin American average). The objective to reach 22.2% of GDP in 2018 remains far-fetched.
But Alexandre Tombini, president of the central bank, defends the country’s track record: “We have six international airports that are now under private concessions (including the largest airports in Brazil), and there has been investment going on in these areas,” he says. “We also have around 2,500 miles of highways under private-sector concession. There is also a programme for ports and railways, so there is a very broad-based infrastructure programme in Brazil going forward... This is a very important process that is happening now in Brazil that should certainly have an impact on total productivity, on the potential of the economy going forward. There is a great deal of investment in infrastructure on the one hand, and qualification of labour [staff training] on the other, so preparing Brazil for stronger growth going forward.”
CREDIBILITY TEST
Officials have recently engaged in an exercise to rebuild credibility and restore investor confidence. The central bank used to be suspected of being soft on inflation. But now, Tombini has pledged that “inflation can and will converge towards the target [4.5%] in the coming quarters.”
Government credibility was also harmed by successive interventions when it limited fuel price increases, which crippled its oil company Petrobras, and when it boosted public sector banks, such as BNDES, via Treasury transfers. Most importantly, credibility was all but demolished on the fiscal front when Brazil missed its own targets (such as last year) or used so many creative accounting tricks (the previous year) that the official fiscal performance had to be treated with great caution.
The big counter-offensive was launched at the end of February, amid a lull in the international capital markets. Mantega said the government would restrict itself to a primary budget surplus of 1.9% of GDP in 2014, and that a budget review will lead to cuts of nearly $20bn. “The government is prepared to go over occasional expenditures within this budget,” he says. “If need be, we will make supplemental sacrifices and may also have other sources of revenue that have not, so far, been allocated in this budget.”
The initial market reaction was positive. But the issue is whether it will be enough to convince Standard & Poor’s, which put Brazil’s BBB sovereign rating on a negative credit watch last June, that the fiscal policy has changed substantially. “The proposed adjustment is a decent one; it is also realistic,” says Octavio de Barros, chief economist at Bradesco, a large Brazilian private-sector bank. “Before that, I considered that Brazil had a probability of 60% to be downgraded; now I see it at 40%.”
Unfortunately, not everybody is convinced. “Economic policy has started to improve since S&P changed its outlook last year,” says David Beker, chief Brazil economist and fixed income strategist at Bank of America Merrill Lynch in São Paulo. “The central bank increased its base rates, the concession programme got underway and the latest fiscal announcement was well thought of. Still investors are not ready to give them the benefit of the doubt. They want to see actual data, not just promises.
“I still see a 65% chance of an S&P downgrade. The latest fiscal measures may delay the move towards the downgrade: they are marginally better. But the data needs to improve a lot on the fiscal side. It is a good step in the right direction, but there is a marathon ahead.”
SCEPTICAL IIF
The International Institute of Finance (IIF), which forecast a modest 1.6% GDP growth this year, has remained rather sceptical. “Policy misalignment remains in place,” says Ramon Aracena, the IIF’s chief Latin America economist in Washington, who doubts a major adjustment will take place in an election year.
So does Marcelo Salomon, chief Brazil economist at Barclays in New York: “The proof of the pudding is in the eating, as they say.” He reckons the primary fiscal surplus will amount to 1.3% of GDP, well short of the new target.
Meanwhile, Bradesco’s Barros rejects the idea of a perceived decline in the Brazilian economy due to its poor growth indicators, higher inflation and twin deficits, against a volatile background in the global capital markets. “This is really silly: Mexico has had an even worse performance [in terms of growth] than Brazil – does this mean a decline? This does not make sense,” he argues. “They are building a platform for future growth. This is a challenge for countries like Brazil, to build a platform for future growth.”
Rousseff now has six months to convince Brazilian voters that she is the best placed to do that. Regardless of who will be elected in October, the next president will have to push through crucial structural reforms in order to pass the credibility test and improve market sentiment. “It is true that Brazil has lost a bit of its lustre,” says Salomon. “What you need is a credibility shock.”
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