“Brazil is not for beginners,” Antonio Carlos “Tom” Jobim once noted. Best known as the composer of The Girl from Ipanema, he mastered Brazil’s diverse harmonics and musical swerves, the worldwide Bossa Nova phenomenon of the 1960s just one chapter in his legacy. Sadly, no Jobim has emerged to master Brazil’s discordant economic rhythms — and fiscal, currency and political harmony seems unlikely anytime soon.
In economics, as in music, sequence matters. Brazil now suffers from multiple crises. Sparked by the country’s primary deficit in 2014 – the first since the Balanced Budget Act was passed in 2000 – government meddling in the energy sector and other markets worsened economic prospects. As a result, the Brazilian economy now suffers lower fiscal standing, capital flight from emerging countries, and a growing current-account deficit. Compound that with politicians paralyzed by the largest corruption scandal in Brazil’s history, unwilling to acknowledge the extent of the fiscal crises and take decisive action. Not for beginners indeed.
The real interest rate has shot up from 5% a year in mid-May to over 7.5% in late August when one looks at inflation-indexed bonds. On Sept. 3, the Central Bank cancelled a bond auction due to market volatility. While fiscal woes were naturally more manageable when the economy was growing, Brazil’s patchwork approach has failed as countercyclical policy. Lack of comprehensive action is largely responsible for lowered expectations. Fiscal rebalancing initiatives underway since January seems mostly political lip service, with no major improvements either on the revenue or cost sides of the federal budget.
Brazil appears headed to the bottom of a business cycle, with market agents forecasting growth to be -2.5% of GDP in 2015, and -1% in 2016. Certainly, no downturn lasts forever – and there are ways out. A combination of higher exports, lower asset prices in foreign currency, diminishing real wages and prices and, hopefully, authentic fiscal rebalancing efforts should improve the country’s prospects. However, here too, sequence counts, especially what precedes in the political arena. The country can ill afford months of “if she stays or if she goes” inaction, as Brazilian President Dilma Rousseff’s popularity wanes and impeachment is brandished around as political currency.
Recent history shows Brazil mobilizing only when on the brink of impending disaster, with market reforms as desperate solutions. Plano Real came under Fernando Henrique Cardoso in 1994, followed by his Balanced Budget Act in 2000, and then the macroeconomic tripod under President Lula da Silva, from 2003 to 2008.
Brazil’s unfortunately consistent beginner’s approach to fiscal management reflects Joseph Stiglitz’s point on the politics of economic stupidity. President Rousseff and her advisors would be wise to follow the general advice of the Columbia University professor and Nobel Prize winner in Economics: Instead of focusing meager resources on temporary tax write-offs that fail to ignite private investments, the country should increase infrastructure public-private partnerships that are relatively inexpensive (from a central government point of view).
Equally important, Brazil should consider the wisdom of the Chinese ideogram for crisis: comprising two separate characters: danger and opportunity. Brazil’s economic danger should be taken as a prime opportunity to immediately enact much needed reforms, such as cutting red tape to simplify tax system maze. According to the World Bank’s Doing Business report, Brazil ranks 120 out of 189 countries overall, and even worse at 177, in the category of tax paying. Microeconomic reforms also are long overdue.
Recently, there had been some tentative signs of reform, focused on the pension system U$30 billion in the red. But with Brazil’s typically singled-minded focus on danger (and not on opportunity), the country’s proposed 2016 budget with a primary deficit helped sink expectations.
No easy answers are available in Brazil, a country where the typical trade-off between growth and austerity does necessarily apply. Nonetheless, after many years of reckless spending, tightening the belt may be the only way to regain investor confidence. If inaction persists, any recovery will likely be derailed by the loss of the coveted investment grade rating that Brazil achieved in 2009, and still maintains by a thread – it is now rated as junk by S&P but still a notch above investment grade on Moody’s and Fitch. Among emerging markets, Brazil has one of the highest costs for rolling the public debt.
All this said, there is little cause for optimism in the short term, and the next few years will be difficult. Yet, there is hope if Brazil can master its crisis management. Coming out of the Dutch disease will help a diversified industry that has been hammered by increasing capital costs, strong currency, and low external demand. The financial system is solid, and demand for investments by SMEs continues to be strong, if the environment allows. Lower real costs should improve productivity, even if marginally. Brazil will be stuck in the middle-income crisis for a while; there are simply too many long term barriers to change that short-term.
The country is paying for its hubris resulting from the boom years of the last decade. The scenario is somber for now. However, Brazil won’t be Greece — having its own currency helps, but it can continue to spiral down. The moment for action is now – if Brazil can find the will and a master composer like Jobim to harmonize its fiscal, currency and political rhythms.