Download Brazil: Fair economic prospects

Research Briefing
Emerging markets
Brazil: Fair economic prospects
October 26, 2012
Or why the doomsayers are wrong
Author
Markus Jaeger
+1 212 250-6971
[email protected]
Brazil’s economic growth has roughly doubled over the past ten years,
increasing from 2.0-2.5% a year to almost 4%. Admittedly, the 1980s and 1990s
set a low standard for such a comparison and the past decade provided an
unusually favourable backdrop to economic growth in the emerging markets.
Editor
Maria Laura Lanzeni
Deutsche Bank AG
DB Research
Frankfurt am Main
Germany
E-mail: [email protected]
Fax: +49 69 910-31877
www.dbresearch.com
DB Research Management
Ralf Hoffmann | Bernhard Speyer
Brazil’s economic fundamentals remain very sound. Record-high FX reserves
and a very manageable current account deficit would allow Brazil to withstand
even a severe balance-of-payments shock in terms of systemic financial
stability. Gross government debt remains high, but is controllable given the
underlying fiscal stance.
China has been a major factor behind the shift in Brazil’s export mix. Whatever
one’s view of Brazil’s intensifying trade relations with China in terms of
economic development, it is incontrovertible that Brazil has taken advantage of
the commodity boom to improve its external and, to a lesser extent, government
finances.
In cyclical terms, the weakness of the Brazilian economy can be largely
explained by sluggish global demand and a strong currency weighing on
manufacturing output. While bank lending has slowed down somewhat,
aggressive central bank rate cuts will sooner or later lead to strengthening
domestic demand and increasing investment.
The good news is that the cyclical recovery will be accompanied by structural
reforms. Many (but not all) measures aim to raise productivity and both public
and private-sector investment. On balance, the measures have a greater focus
on supply than demand than in the past. The reforms, combined with a cyclical
recovery, will underpin higher savings and investment, making it very unlikely
that the economy will grow less than 3.5% over the medium term.
Slowing growth momentum
DX
Real GDP, % yoy
10
8
6
4
2
0
-2
-4
2003
Source: IBGE
2004
2005
2006
2007
2008
2009
2010
2011
2012
Brazil: Fair economic prospects
Brazil benefited from favourable global economy
Cyclical or structural?
1
Real GDP, % change
8
7
6
5
4
3
2
1
0
-1
1995
2000
2005
Annual average
2010
Period average
Sources: IMF, DB Research
Tide lifts all boats?
2
Real GDP, %, avg
82-91
92-01
Turkey
Saudi Arabia
Russia
Poland
Mexico
Indonesia
India
Brazil
China
12
10
8
6
4
2
0
-2
02-11
Source: IMF
Strong external liquidity
3
% of FX reserves
350
300
250
Brazil’s economic growth has roughly doubled over the past ten years,
increasing from 2.0-2.5% a year to almost 4% (chart 1). Admittedly, the 1980s
and 1990s set a low standard for such a comparison. After all, the 1980s were a
“lost decade”, when Brazil struggled to resolve its external debt problems. The
1990s saw significant structural reform and economic liberalisation. Monetary
stabilisation was also being achieved by the middle of the decade. This was
followed by repeated financial crises due to an exchange-rate-based
stabilisation that was insufficiently supported by fiscal policy. This led to
currency overvaluation and repeated currency crises, weighing on economic
growth.
In a comparative perspective, Brazil’s economic performance in the 2000s was
solid, but not spectacular. After a choppy beginning with the US equity market
crashing, neighbouring Argentina defaulting and foreign investors taking flight in
the run-up to the 2002 presidential elections, the 2003-08 period provided a
near-perfect backdrop to stronger economic growth. First, global growth
underpinned by a strong US economy and an emerging China led to a rapid
expansion of global trade. Second, global interest rates, led by the Fed and
underpinned by the so-called Asian savings glut, were extremely low by
historical standards, causing capital flows to emerging markets to grow rapidly.
Third, commodity prices started to rise across the board and reached levels not
seen in many decades, largely due to surging Chinese demand. This benefited
natural-resource exporters like Brazil.
Against such a favourable backdrop, Brazil was not the only emerging economy
to experience higher economic growth (chart 2). China had been growing at
more than 10% p.a. for more than two decades but saw its growth accelerate
during the past decade. India experienced a growth acceleration on the back of
the economic reforms of the early 1990s with real GDP growth accelerating to
almost 8% from 5.5%, while Russia also registered strong growth of almost 5%
following the recovery from the 1998 default, subsequent stabilisation and rising
energy prices. The external environment no doubt supported growth, and not
just in Brazil.
Structural reform and financial stabilisation were also important. Structural
reform under Cardoso (1995-2003) – e.g. privatisation, monetary stabilisation
and trade liberalisation – put in place the conditions for the higher, sustained
economic growth of the 2000s. The definitive economic-financial stabilisation
under Lula (2003-10) allowed Brazil to reap the benefits of previous reforms,
supported by improving terms-of-trade and favourable international financial
conditions. The 2008-09 financial crisis and economic downturn appeared to be
merely a speed bump. After growing almost 8% in 2010, growth slowed to less
than 3% in 2011 and is set to average less than 2% in 2012.
200
150
100
50
0
2000 2002 2004 2006 2008 2010 2012
EFR*
"Safe" level
*Current account plus external debt amortisation due over
next 12 months.
It would be a mistake, however, to extrapolate this trend and regard this as the
beginning of longer-lasting economic stagnation. First of all, Brazil was never
going to grow more than 4% or so and it was never going to grow faster than the
other BRIC countries, Russia possibly excepted. It is certainly likely that Brazil
will face less favourable external circumstances over the coming years than it
did during the past decade. But thanks to solid economic fundamentals, overall
sensible macro-policies and ongoing structural reform efforts, we see little
reason why real GDP growth should average less than 3.5% over the medium
term.
Source: DB Research
2
| October 26, 2012
Research Briefing
Brazil: Fair economic prospects
Brazil continues to enjoy solid fundamentals
Gradually declining government
debt (1)
4
Public sector debt, % of GDP
60
50
40
30
20
10
0
Brazil’s economic fundamentals remain sound. The sovereign, for what it is
worth, carries an investment grade rating. By contrast, a decade ago, Brazil was
heavily exposed to balance-of-payments shocks, as evidenced by repeated
currency crises. Today, it is well positioned to absorb virtually any external
shock without running the risk of broader financial instability. As the 2008 global
crisis demonstrated, Brazil, like most other (emerging) economies, may not be
able to avoid negative consequences in terms of lower growth (read: no decoupling). But, unlike in the late 1990s and early 2000s, such shocks do not
prove destabilising anymore in the sense that the economy does not sustain
“structural” damage, leaving its growth potential undiminished.
1
-10
-20
02 03 04 05 06 07 08 09 10 11 12
Net foreign-currency
Net debt
Source: DB Research
Gradually declining government
debt (2)
Gross general government debt, % of GDP
90
80
70
60
50
40
30
20
10
0
02 03 04 05 06 07 08 09 10 11 12
Domestic debt
Source: DB Research
External debt
5
Brazil is a net external creditor . The public sector (basically: government,
central bank and state-owned enterprises) is also a net foreign-currency
creditor, allowing it to provide foreign-currency liquidity to the private sector if
necessary. Even a severe balance-of-payments shock can be absorbed through
a combination of exchange rate depreciation and provision of foreign-currency
liquidity to the private sector (as happened in 2008). In the early 2000s, external
financing requirements amounted to 200% (chart 3). Today they are a mere
50%. The current account deficit is currently running at less than 3% of GDP
and is easily financed (in fact, overfinanced) by FDI inflows. Central bank FX
reserves have reached record-high levels of almost USD 400 bn. While the
private sector as a whole is exposed to a sudden stop in capital inflows, the
systemic impact of individual corporate defaults would be negligible. Last but not
least, the systemically important banking sector runs manageable foreign
exchange rate risk.
While gross government debt remains elevated by emerging markets standards,
the net debt of the public sector is significantly more favourable. Gross
government debt amounts to 64% of GDP (under the IMF definition), but net
public-sector debt stands at a much lower 35% of GDP (charts 4 and 5). The
liability structure, historically a major vulnerability, has also improved
significantly, with a much greater share of debt consisting of fixed-rate or
inflation-linked rather than foreign-currency or interest-linked instruments. The
2008 shock decisively demonstrated that Brazil can survive even the severest of
shocks. In fact, currency depreciation led to a decline in net debt (chart 6).
Gross public-sector financing requirements remain elevated, but are significantly
lower than in the past.
Impact of market shock on net public-sector debt*
6
% of GDP**
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Interest rate
1.8
2.1
1.9
1.8
1.5
1.6
1.7
2.1
1.9
1.9
FX
15
11.4
1.9
2.1
-0.9
-4.6
-5.3
-5
-5.2
-7.1
16.8
13.5
3.8
3.9
0.6
-3
-3.6
-2.9
-3.3
-5.2
Total
*Footnote: Stress scenario assumes a three-standard deviation shock to the real interest and exchange rates, similar to the
2002 shock. ** Net public-sector debt
Source: Treasury
The outlook for public-sector debt sustainability is fair. If the government
maintains a primary surplus of 2.5% of GDP (below the present 3.1% target),
net debt will fall to below 30% of GDP by 2015. In other words, the current
primary surplus target of 3.1% of GDP is more than sufficient to keep the debt to
1
3
| October 26, 2012
Disregarding foreign holdings of domestically-issued public debt.
Research Briefing
Brazil: Fair economic prospects
GDP ratio on a declining path. In fact, we estimate that under fairly conservative
assumptions of 3% real GDP growth and 5% real interest rates, a primary
surplus of 1% of GDP would be sufficient to stabilise the debt ratio at 35% of
GDP or so. In other words, the government enjoys sufficient policy space to let
automatic stabilisers help absorb the growth impact of an external shock and
even to implement anti-cyclical policies, if necessary.
Rise of China and Brazilian growth
China is single largest export
destination
7
China has rapidly emerged as a major factor in the global economy. Having
overtaken Japan and Germany, it is today the world’s second-largest economy.
Double-digit real GDP growth, combined with a particularly resource and
investment-intensive economic development strategy, has been a major
contributor to the sharp rise in commodity prices and rapidly rising Brazilian
exports to China. China is today Brazil’s largest trading partner (if the EU is not
counted as a single entity), accounting for more than 17% of total exports in
2011 (chart 7).
% of exports
China
17.3
US
10.1
Others
54.7
Argentina
8.9
Japan
3.7
Source: MDIC
Netherlands
5.3
Changing export structure
8
% of merchandise exports
100%
80%
60%
40%
20%
Manufacture
Food
Fuel
Ores & metals
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
0%
Agriculture
Source: World Bank
Strong exchange rate
9
REER, 2004=100
180
160
140
To what extent Brazil’s rising dependence on China is a blessing or a curse is
subject to debate. Some worry about the “Dutch disease” (whereby rising export
prices appreciate the exchange rate and undermine the competitiveness of the
manufacturing sector). Others will argue that a reliance on commodity exports
nonetheless allows a country to climb the value-added ladder and foster
economic development. Whatever one’s view, it deserves highlighting that Brazil
has taken advantage of the commodity boom to improve its external and, to a
lesser extent, government finances.
Government dependence on direct commodity revenues is quite limited, unlike
in other Latin American economies (e.g. Chile, Mexico, Venezuela). Brazil is
also unusually diversified in the commodity space with exports ranging from
agricultural raw materials, food and energy to iron ore and metals, not to
mention continued sizeable manufacturing exports. It is possible, perhaps even
likely, that Chinese demand (growth) for iron ore will slow down once it shifts
towards a more consumption-oriented growth model; but Chinese demand for
soy is unlikely to decline over the medium term. It is incontrovertible that Brazil
is far less sensitive to a downturn in commodity prices than many other
emerging economies, including Russia, which runs a huge non-oil deficit.
China is also becoming an important source of foreign (direct) investment.
Unfortunately, data availability is poor given that a lot of Chinese FDI is routed
through offshore financial centres. Nonetheless, anecdotal evidence based on
publicly announced deals suggests that Chinese FDI has been rising tangibly.
120
100
80
60
04
05
06
07
08
09
10
11
12
Brazil
China
India
Mexico
Russia
Source: BIS
4
China has also been a major factor behind the shift in Brazil’s export mix. Strong
demand for commodities and an appreciating exchange rate have resulted in
commodities’ growing and manufactures’ declining share in Brazilian exports
(chart 8). Brazilian trade relations with China are unbalanced, or very
complementary, depending on one’s point of view. Soy, iron ore and oil
represent the lion’s share of Brazilian exports to China, while 98% of Chinese
exports to Brazil consist of manufacturing goods. This reflects China’s
comparative advantage in manufacturing goods and Brazil’s advantage in
commodities.
| October 26, 2012
Last but not least, it is important to remember that Brazilian exports amount to a
mere 11% of GDP. Brazil’s export dependence is far less significant than that of
its BRIC peers. Brazilian exports to China amount to less than 2% of GDP, not
exactly an exorbitant figure. The bottom line is that Brazil has undoubtedly
benefited from China’s rise, but unless China suffers a complete economic
meltdown, the downside risks stemming from Brazil’s increasingly close
relationship with China appear quite manageable.
Research Briefing
Brazil: Fair economic prospects
Is the slowdown cyclical or structural?
Continued credit expansion
10
Bank credit to private sector, % of GDP
60
50
40
30
20
10
Public
Private
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
0
Foreign
Source: BCB
Strong labour market
11
Unemployment, %
In cyclical terms, the weakness of the Brazilian economy can be largely
explained by sluggish global demand and a strong currency weighing on
manufacturing output. The currency is softer than a year ago, but in real terms it
has appreciated the most among the BRIC currencies on the back of improving
terms-of-trade and strong capital inflows over the past ten years (chart 9). The
Brazilian government appears adamant about preventing further appreciation of
the currency and has proved its willingness to supplement FX intervention with
so-called capital flow measures. Commodity exports are weaker but commodity
prices have not crashed and are likely to rise as soon as a broader global
economic recovery takes hold. Bank lending growth has slowed down somewhat from very high levels, but aggressive central bank rate cuts will sooner or
later lead to improving household finances and a greater willingness among
(private-sector) banks to lend (chart 10). Unemployment remains very low
(chart 11). In other words, the conditions for demand to recover are in place.
Brazil does face significant supply-side constraints. The so-called custo Brasil
limits the economic growth potential. It is, however, unclear that Brazil’s growth
potential, approximated by its actual growth performance of the past few years,
has declined. If it has, Brazil is certainly able to soften this constraint with the
help of structural reform. Even if the current slowdown is more structural than
cyclical, it won’t be too diffcult for Brazil to maintain 3.5-4.0% annual growth if it
continues down the path of structural reform (see below).
14
12
10
8
6
4
2
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
0
The most important constraint on growth is a low savings and investment rate.
Many Asian emerging economies invest 30-40% of GDP a year. Public and
infrastructure investment also tends to be high, often in the 4-8% of GDP range.
By contrast, total investment in Brazil has averaged less than 20% of GDP and
public and / or infrastructure investment (excluding SOE investment) has
typically been less than 2% of GDP (chart 12). Not surprisingly, Brazil is
suffering from well-known bottlenecks with regard to infrastructure. Fixing
infrastructure bottlenecks will be key to raising potential growth (chart 13).
Source: IBGE
Brazil suffers from structural deficiencies, including infrastructure
Suffering from low investment & savings
12
% of GDP, 2002-11, avg
60
50
40
13
Health & primary Higher education
education
& training
Goods market
efficiency
Rank
Overall
Infrastructure
Brazil
48
70
88
66
104
China
29
48
35
62
59
India
59
84
101
86
75
Russia
67
47
65
52
134
Source: World Bank
30
20
10
Investment
Investment, avg
Source: IMF
Savings
Savings, avg
Turkey
Taiwan
Russia
Poland
Mexico
Korea
Indonesia
India
China
Brazil
Argentina
0
As far as savings are concerned, Brazil suffers from low household and
government savings rates. The public sector is in fact a net dissaver. Multiple
2
explanations have been put forward, all of them quite plausible . Two
explanations seem particularly relevant. First, large government transfers,
especially social-security-related transfers, limit households’ incentives to save.
Implicit pension (and health) liabilities are significant in Brazil and a broader
social-security and, above all, pension reform would be desirable, especially
given adverse medium-term demographic developments and the concomitant
pressure this will put on government current expenditure and transfers
2
5
| October 26, 2012
De Faria, J.C. (2012), Brazil: The quest for growth, Deutsche Bank; OECD Economic Survey:
Brazil (2011); Jaeger, M. (2009), Brazil 2020, Deutsche Bank Research.
Research Briefing
Brazil: Fair economic prospects
Large implicit liabilities to weigh on
public savings
(chart 14). (The reform of the social security regime for civil servants earlier this
year was a good start.)
14
% of GDP
Second, and relatedly, the government spends too much in terms of current
expenditure and hence does not save (and invest) enough. Limiting government
current expenditure would be welcome and is discussed intermittently in
Brasilia. It is crucial that Brasilia does not waste the income generated by higher
growth entirely on consumption. Keeping down public-sector consumption and
other current expenditure would go a long way in terms of generating higher
economic growth. Other factors also contribute to the low level of savings and
investment: lack of a functioning domestic, local-currency, long-term capital
market, directed lending, high bank reserve requirements, a cumbersome legal
system, a high level of short-term government debt etc.
150
100
50
0
-50
Russia
Brazil
China
India
NPV of pension spending change,
2010–50
But addressing infrastructure bottlenecks and raising investment (and savings)
will be key to unlocking the economy’s growth potential. Improving the
conditions for private-sector investment (read: structural reform, including legal,
labour, tax) would also be welcome. After all, Brazil ranks 126th out of 183
countries in the latest World Bank “Ease of Doing Business” survey (behind
Uganda and Swaziland) (chart 15).
NPV of health care spending change,
2010–50
GG debt, 2011
Source: IMF
Selected indicators for upper middle income countries (out of total of 49 countries)
World Bank 'Doing
Business' Survey
Dealing with
Construction
Permits
15
Trading
Across
Borders
Enforcing
Contracts
Resolving
Insolvency
27
2
5
10
10
5
8
8
3
11
43
21
21
12
11
12
17
17
34
5
6
8
21
13
32
32
15
17
2
25
25
44
1
40
11
19
31
15
21
2
21
10
23
24
19
24
12
38
30
9
17
35
33
16
4
20
43
17
39
17
39
40
30
10
27
35
47
49
11
30
39
29
46
1
17
43
37
33
16
32
30
28
41
34
34
41
49
43
29
42
25
48
48
49
47
20
46
Rank
Starting a
Business
Thailand
1
28
4
Malaysia
2
13
30
South Africa
6
9
10
Chile
7
6
Peru
8
Colombia
9
Mexico
Getting
Electricity
Registering
Property
Getting
Credit
Protecting
Paying Taxes
Investors
2
6
17
5
18
17
1
1
33
24
1
23
11
16
16
27
25
26
9
37
13
27
12
39
Turkey
22
22
39
China
31
44
48
Argentina
38
42
Russia
40
Brazil
Venezuela, RB
Source: World Bank
Economic policy & structural reforms under Dilma3
The administration of President Dilma Rousseff has recently launched a new
string of reforms aimed at improving competitiveness and productivity (chart 16).
In other words, the government is not solely relying on demand-side measures
to maintain growth. The Dilma government has thus far maintained a relatively
tight fiscal policy in the face of below-potential economic growth and has instead
relied on aggressive central bank monetary easing. The reliance on monetary
rather than fiscal stimulus seems quite sensible given continued high interest
rates and the relatively high level of government debt. In this context, the
government’s stance on public-sector wage claims is welcome and signals a
3
6
| October 26, 2012
Brazil after the elections – what’s next (2010). Deutsche Bank Research.
Research Briefing
Brazil: Fair economic prospects
Major policy measures & programmes
(Brasil Maior, PAC)
16
Investment
Airport, railway & road concessions
Infrastructure (PAC 1 and 2)
more determined attitude to keep public-sector wage expenditure low and allow
greater room for monetary easing. This should be seen as an attempt to kickstart investment rather than supporting consumption through increased
expenditure and only moderate (rather than aggressive) policy lending. The
government continues to provide funding to public banks in order to boost credit.
4
The government has taken measures to support industry (Brasil Maior) .
Basically, the objective is to raise investment from less than 19% of GDP to 23%
of GDP by 2014. This looks ambitious, but the general thrust of this policy is to
be welcomed. The government has announced payroll-tax cuts and reduced the
rates industry pays for power and has offered / will offer private companies
licences to build and operate roads and railways as well as major airports and
ports. As already mentioned, the government also pushed a public-sector
pension reform through congress. While the latter’s immediate financial effects
are limited, it will help improve the outlook for long-term public-sector solvency.
On the negative side, the government has also increased import tariffs to protect
troubled industries, pressured banks to lower interest rates and compelled
utilities to cut electricity rates in exchange for renewing their concessions.
Tax measures
Payroll tax cuts
Other tax measures (e.g. IPI)
Other
Electricity tariff reductions
Credit policy
Export financing
Government purchases
FX policy
Import duties
Sources: MDIC, Fazenda, DB Research
All of this is far from representing large-scale liberalisation, but the combined
measures seek to address, however imperfectly, some of the supply-side
constraints limiting savings, investment and economic growth.
BRICs in comparison
17
Real GDP growth,%
14
12
10
8
6
4
2
0
-2
-4
-6
-8
1986
1991
1996
2001
2006
Brazil
India
2011
2016
China
Russia
Sources: IMF, DB Research
Financial stability is here to stay
18
CDS spreads, bp
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
01
03
05
Source: DB
07
09
11
Last but not least, the government remains committed to PAC 2 – the government’s infrastructure and growth acceleration programme. The programme is
encountering a number of problems and delays, but the basic thrust of the
strategy aimed at raising public-sector infrastructure investment is sound. If
interest rates experience a secular decline, the public sector will free up
significant fiscal resources. It can then use these resources to pay down debt
and accelerate the drop in domestic interest rates (and thus make private-sector
investment cheaper), cut taxes (and enhance private-sector investment returns)
or raise public-sector investment. This will help increase investment and support
medium-term economic growth.
Medium-term growth outlook remains fair
Brazilian economic growth has been negatively affected by an unfavourable
global economic backdrop. Most developed and emerging economies are
suffering a similar down leg. A strong currency combined with weaker foreign
demand has resulted in a stronger-than-expected slowdown in Brazil. Five-year
trailing real GDP growth is still running at more than 3.5% (Chart 17). Brazil’s
fundamentals remain solid (chart 18). The banking sector, despite increased
NPLs, remains fundamentally sound and well-capitalised, the recent failure of
some smaller banks notwithstanding.
None of this is meant to deny that supply-side constraints may have become
5
more important . That said, domestic (real) interest rates will be lower in the
coming years, providing the government with greater fiscal resources to foster
private-sector and public-sector (infrastructure) investment thanks to lower
interest payments on its debt (chart 19), provided it succeeds in keeping a lid on
(or even reducing) government consumption and transfers. Structural reform,
especially greater private-sector participation in infrastructure development and
management, should also support higher investment and raise productivity. With
a gently rising investment ratio, Brazil is quite unlikely to grow less than 3.5% a
year over the medium term (chart 20). Flanked by ongoing structural reforms,
real GDP growth of around 4% should be achievable, even if the global
4
5
7
| October 26, 2012
For Brasil Maior, see http://www.brasilmaior.mdic.gov.br
DB Research, Brazil – Time to move towards a new growth strategy, 2012.
Research Briefing
Brazil: Fair economic prospects
Brazil stands out
19
Government interest payments, % of GDP, 2011
7
6
5
4
3
2
1
0
economic backdrop this decade remains, as is likely, weaker than in the past
decade.
High investment = high growth
20
2002-11, avg
Turkey
Real GDP growth, %
Source: Fitch
Indonesia
India
Russia
Mexico
Brazil
Poland
Taiwan
Korea
China
12
China
10
8
India
Argentina
6
Russia
Turkey
4
Brazil
Taiwan
Poland
2
Indonesia
Korea
Mexico
0
0
5
10
15
20
25
30
35
40
45
50
Investment, % of GDP
Sources: IMF, DB Research
Markus Jaeger (+1 212 250-6971, [email protected])
© Copyright 2012. Deutsche Bank AG, DB Research, 60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite “Deutsche
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decision about whether to acquire the product.
Internet/E-mail: ISSN 2193-5963
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| October 26, 2012
Research Briefing