Download Brazil: Stability Pays off – Strong Growth, but also Major

E CON OMI C RE SE ARCH & CORPORAT E D E VE LOPME N T
Working
Paper
June 21, 2010
} MA C RO ECONO M ICS
140
} F INA N C IAL M AR KETS } EC O NOM IC POL IC Y
} S ECTO RS
Gregor Eder
Brazil: Stability Pays off – Strong Growth, but
also Major Challenges Ahead
Economic Research & Corporate Development
AUTHOR:
GREGOR EDER
Tel.: +49.69.2 63-5 33 58
[email protected]
Working Paper / No. 140 / June 21, 2010
Brazil: Stability Pays off – Strong Growth, but
also Major Challenges Ahead
As recently as ten years ago, hardly anyone would have believed that overall, Brazil would
emerge relatively unscathed from a crisis on the scale of the latest global economic and
financial problems. In previous periods of crisis, no matter whether caused by external
shock or due to home-made problems, the largest economy in Latin America has more
than once been on the brink of default. The key factor in this rising ability to cope with
crisis is the stability-oriented economic policy of the past decade. The foundations of this
policy were laid by Fernando Henrique Cardoso, initially during his term in office as
Finance Minister (1992-1994) and subsequently as President (1994-2002). The current
President, Luiz Inácio Lula da Silva, has carried on the policy of his predecessor. Lula's
second term in office finishes at the end of this year and the constitution stipulates that
he may not run for office again.
Cornerstones of Brazilian economic policy
The key elements of this stability-oriented economic policy are fiscal discipline, a monetary policy that is required to achieve a pre-defined inflation goal ("inflation targeting")
and a flexible exchange rate. In the context of public finances in particular, Brazil has
made considerable progress in recent years. Thanks to moderate budget deficits, total
public debt in relation to gross domestic product (GDP) has gone down significantly,
from about 86% in 2002 to less than 60% in 2007. This ratio has nevertheless risen again
somewhat (due to the crisis) in the last two years, most recently to 67% of GDP.
The structure of government debt has also improved considerably. For a long time a
substantial portion of public debt was denominated in foreign currency or was at least
dollar-indexed. As a result, the exchange rate was automatically a major conductor of
financial market shocks: any depreciation of the Brazilian real would bloat the public
debt in terms of the national currency. This in turn generally gave rise to doubts on the
financial markets about the sustainability of public finances, which put the currency
under more pressure. Most Brazilian public debt is now denominated in the local currency. In fact, Brazil currently has more assets in foreign currency than liabilities, putting
it in a net creditor position. As a result and unlike in the past, any depreciation of the real
acts as a macroeconomic stabilizer since it has a positive impact on debt momentum.
The appreciable improvement in the foreign currency liquidity position has also made a
significant contribution to stabilizing the macroeconomic environment in Brazil, with
the trend in commodity prices playing a major role. For years, Brazil generated fairly
substantial current account surpluses. The inflow of net foreign direct investment more
than compensated for the deficits recorded in the last two years. As a consequence, foreign exchange reserves, which constitute a natural safety cushion for a possible crisis
situation, have continued to rise until recently. At the end of April 2010 they amounted to
USD 246bn, equivalent to more than twelve months worth of imports – a high figure by
international standards.
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Economic Research & Corporate Development
Working Paper / No. 140 / June 21, 2010
Direct investment covers bulk of the current account deficits
Current account balance & inflow of net foreign direct investment, in USD bn
40
30
20
10
0
-10
-20
-30
-40
-50
2005
2006
Sources: IMF, own forecasts.
2007
2008
2009
Current account balance
2010f
2011f
Net foreign direct investment
Economic boom after a short but sharp recession
Brazil has of course also felt the effects of the global economic and financial crisis. In the
fourth quarter of 2008, real GDP posted a 3.3% decline against the previous quarter, after
seasonal adjustments. Economic output fell again by 1.5% in the first quarter of 2009.
Investment was hit particularly hard, plummeting about 20% over the two quarters of the
recession combined. Thanks to the stable macroeconomic framework and the associated
high credibility of the economic policy, however, policymakers were able to respond
swiftly to the crisis with anticyclical measures. The government approved an extensive
economic stimulus package including temporary tax cuts, subsidies and other increases
in expenditure. The monetary policy response was also aggressive: between January and
July 2009 the Brazilian central bank cut its key interest rate in several steps by a total of
500 basis points to 8.75%, a very low interest rate level by Brazilian standards.
This economic policy stimulus proved effective. Brazil's recession came to an end as early
as the second quarter of 2009, when the economy grew by 1.5% in comparison with the
previous quarter. Since then the economic momentum has continued to pick up speed.
In the first quarter of 2010 GDP climbed by 2.7%. This is the strongest quarterly rise in six
years. Growth was once again driven by private consumption and investment, with the
latter up 7.4% on the preceding quarter.
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Economic Research & Corporate Development
Working Paper / No. 140 / June 21, 2010
First a short but sharp recession, followed by an economic boom
GDP components, percentage change over previous quarter, seasonally adjusted
8
6
4
2
0
-2
-4
-6
-8
-10
-12
2005
Source: IBGE (EcoWin).
2006
2007
2008
GDP
Investment
2009
2010
Private consumption
The robust economic trend looks set to continue for the time being, as suggested by the
latest indicators for Q2. Industrial production registered a seasonally-adjusted drop of
0.7% in April on the previous month, but this decline must be seen in the context of the
strong 3.4% rise in March and should therefore not be overrated. Despite the latest drop
the current production level still exceeds the average of the first quarter by a good 2%.
Capacity utilization in industry now stands at 83%, back above the long-term average of
81% (January 2003 to April 2010), which in turn points to brisk investment activity in the
coming quarters.
As a counter-measure against overheating of the Brazilian economy the government
announced expenditure cuts in May, for the second time within a few months. Previously
it had already withdrawn parts of its crisis-based fiscal package, such as temporary subsidies and tax breaks, in order to avoid heating up domestic demand even more. Monetary policy also responded to the strong growth and rising inflationary pressure. After the
key interest rate had remained at 8.75% since July 2009, the central bank increased it at
the end of April and the beginning of June in each case by 75 basis points to its current
level of 10.25%. Further steps are very likely in the coming months. By the end of 2010, we
expect to see the key interest rate at 11.5% to 12%. Inflation is likely to average about 5%
this year (May 2010: 5.2%).
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Economic Research & Corporate Development
Working Paper / No. 140 / June 21, 2010
Brazilian central bank starts tightening interest rates
SELIC target rate, in percent
20
18
16
14
12
10
8
09
Ja
nu
ar
y
10
Ju
ly
08
Ja
nu
ar
y
09
Ju
ly
07
Ja
nu
ar
y
08
Ju
ly
06
Ja
nu
ar
y
07
Ju
ly
05
Ja
nu
ar
y
06
Ju
ly
Ja
nu
ar
y
05
6
Source: BCB (EcoW in).
After a buoyant first half-year we expect economic momentum to ease somewhat during
the rest of this year, not least against the background of an economic policy that has an
increasingly dampening effect. In real terms the Brazilian economy should grow by 6.5%
overall in 2010, after a slight decline of 0.2% in 2009. We then expect a rise of 5.5% for next
year. This means that the largest economy in Latin America would grow more strongly
than the region overall in the foreseeable future, for which we forecast growth of 4.6% this
year and 4.4% next.
Buoyant growth momentum and restrained reform zeal
Thanks not least to its successes on the economic policy front and the resulting stability,
Brazil was able to notch up significantly higher growth in the past five years than in the
previous decade. The following chart illustrates this strikingly. Over the next five years we
expect an even more dynamic trend with average GDP growth of around 5% a year, before
growth rates level off at about 4.5% from 2016 onwards. A key factor in the quite positive
outlook up to 2015 is the fact that extensive investment projects, especially in infrastructure, are expected ahead of the major sporting events held in Brazil (the FIFA World Cup
in 2014 and the Summer Olympic Games in 2016), which will of course boost growth. The
infrastructure itself is currently still one of the major bottlenecks in the Brazilian economy. For example, many of the commodities such as soya destined for export must be
transported to the ports by truck as the rail network is underdeveloped.
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Economic Research & Corporate Development
Working Paper / No. 140 / June 21, 2010
Trend growth has been rising for years
Real GDP growth compared to previous year, in percent
7
Ø 2006-2010:
4.3%
Ø 2001-2005:
2.8%
6
5
Ø 2011-2015:
5.1%
Ø 1996-2000:
2.0%
4
3
2
1
0
-1
1996
1998
2000
2002
2004
2006
2008
2010f
2012f
2014f
Congressional and presidential elections will be held in Brazil in October of this year. The
most promising candidates for the presidency are Dilma Rousseff, the former Chief of
Staff and therefore the right hand of President Lula, and Jose Serra of the PSDP. Regardless of the election outcome, a radical change of course is not expected from either of
them. The current economic policy has proved its worth too much, especially in the financial and economic crisis, for a new president to gamble with these successes. On the
other hand, however, noteworthy structural reforms, e.g. in social security and the labor
market, are not really likely since they could probably not be pushed through given the
difficult majority situation in congress and the great influence exerted by the governors
of the federal states. Moreover; pressure for reform is also considered to be relatively low
overall, given the backdrop of high growth rates.
As a result our medium and long-term GDP forecast is based on the assumption that
there will be no major structural reforms in Brazil in the next few years. Nor do we expect
an appreciable rise in the relatively low savings rate. If there were positive surprises in
this respect in the coming years, the Brazilian economy could also grow significantly
more strongly than we have assumed in our base scenario.
In conclusion, two major "works in progress" are presented at this point by way of example. The incoming government should direct their attention to these in the next few years
– not least in order to ensure dynamic economic performance over the long term.
Public finances
Despite the progress made with public finances as described above, two major structural
challenges remain in this respect. The first involves the uninterrupted upward trend of
government expenditure. Public-sector expenditure last year was probably around 45%
of GDP. Ten years ago it was just 36%. This means that the primary surpluses of past years
were achieved principally through higher taxes and not through discipline in terms of
expenditure. The tax burden did indeed rise to 35% of GDP in 2009, from 27% in 1998. A
higher tax burden and the complexity of the Brazilian tax system are increasingly acting
as growth inhibitors. The second structural challenge lies in the rigidity of the state budget. About 75% of revenue is consumed by fixed budget items such as social security
payments and transfers to regional authorities. This naturally restricts a government's
discretionary room for maneuver to a very large extent.
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Economic Research & Corporate Development
Working Paper / No. 140 / June 21, 2010
Investment
Even though the investment trend has been upwards in recent years, investment does
remain at quite a low level in an international comparison. In 2009, gross capital investment was 16.5% of GDP. In other emerging markets, especially in Asia, the corresponding
figure is often more than 30%. Both government and private investment levels are too
weak for a country that is in the process of catching up economically. The low level of
private investment could be rooted chiefly in the considerable tax burden and in the still
high cost of finance (i.e. high interest rates in real terms). How could investment be
boosted? A conceivable approach would be to reduce public expenditure – not in absolute terms, but in relation to GDP. The resulting leeway could be used to reduce debt or cut
taxes. Debt reduction could result in falling interest rates. As in the case of tax cuts, this
would also have a positive effect on the private sector's willingness to invest.
These assessments are, as always, subject to the disclaimer provided below.
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