dimanche 22 décembre 2013

Party time in Brazil, the world is looking to Brazil with enthusiastic eyes since it will be hosting soon the World Cup and the Olympics in 2016 that seems as recognition of its ascending influence in the international markets.
Indeed, it has many reasons to celebrate.  The country has made remarkable economic and social progress in the last decade. It has raised 22 million people out of poverty since 2003 and built a stable economy. It fought successfully against the big scary ghost from its past, the hyperinflation, by granting autonomy to its Central Bank that in turn, implemented the inflation targeting during president Fernando Henrique Cardoso government (1995-2002) which drove annual inflation down from 916,46% in 1994 to 5,97% in 2000 and by creating the Law of Fiscal Responsibility that sought to control municipal and states expenses and promote more transparence in public spending. It’s an economy with full-employment (unemployment rate of 5,5%, OECD Economic Surveys Brazil, October 2013) and strong internal consumption. Moreover, many state-owned companies were privatized and flourished as a result of being allowed to operate at arm’s length from the government and became strong global players as Vale, a mining giant and Embraer, an aircraft-maker.
Nevertheless, Brazil has not seemed to have done all his homework to boost economic development. Three years of weak growth shows clearly that Brazil needs to review its economic model. In the last “Global Competitiveness Report 2012-2013” released by the World Economic Forum, structural reforms were cited as the main pillars to drive productivity and competitiveness. And it seems that Brazil is not following the guidelines as we would expect from a country that wants to sustain its economic growth in the long-term.
The first pillar is government attitudes toward markets and its capability of maintaining an efficient management of its operation. In Brazil, there is a lack of transparence and trustworthiness in the government. This can be illustrated by an incident that was in the international press recently, the case of the OGX, a company engaged in the oil & gas exploration and production, that was one of the most negotiated stocks in Brazil, it appreciated 78,94% 4 years after its IPO and now its stock worth last than 0,1 €. This was a consequence of a company that was highly leveraged and promised unrealistic potentials for its reserves, revealing a regulatory bottleneck that enabled a CEO from a public capital company to make excessive statements which in the end damaged many investors. Furthermore, there is an excess of government intervention in the economy. The government created a cap for electricity prices in 2012, aiming to reduce overall production costs in the economy and control inflation. Nonetheless, instead, these new terms of the concessions caused several of Brazil’s largest power companies to suffer significant decreases in profitability and investors experienced a long-lasting detrimental effect on shareholder value – which will probably cause underinvestments for the future. Also, as an anti-inflationary measure, the government forced Petrobras, a mixed capital oil company, to hold down the price of petrol, which in turn, made it had losses of US$ 1,1 billion from January to October 2013, as it was importing oil at a higher price than it sold on the domestic market. In addition, the tax burden is extremely high, between 2010-2013, the government revenue weighted 37% of its GDP, much higher than its Latin America counterparts (chart below):

The other pillar is infra-structure and the absence of a rebound in investment (currently at 19% of GDP) reflects the current challenge to rebalance the economy and maintain the country’s economic growth. We can observe in the following chart that the level of Gross Capital Formation as a % of GDP (average 2009-2013) is lower than in other emerging countries:

The country dealt pretty well with the global financial crisis of 2007/2008 achieving a GDP growth rate of 7,53% in 2010. This achievement was based on its good macroeconomic stability but it was also a consequence of China growing at fantastic rates and being hungry for Brazilian commodities. In addition, there was a sluggish  America that was seeking for the Emerging markets risk premium. Nonetheless, the international economic scenario changed. But is it sustainable? Maybe not, according to Israel Malkin and Mark Spiegel from the Federal Reserve of San Francisco, China is facing a “middle-income trap” in which rising wages erode global competitiveness, leading to a marked slowdown. Furthermore, the US investors might reduce their exposition to the Emerging Markets as the Fed reduces its asset buying programs and besides, the American stock market is enjoying an uptrend.

But what is the best path for development from now on?

Short answer is: Brazil needs reforms. But a longer answer is more political: these reforms will not come until voters value policies that will generate good results in the long-term. We already could observe that a combination of slower growth and an assertive new middle class is forcing political change.  Brazilians are tired of a system which has a Scandinavian tax burden and a third world country public services. A country which is serious about a long-term solution should improve the level of education and create a plan to fills the current infrastructure gaps.  A model that only stimulates the consumption is clearly not a long-term solution, on the other way around, it can imposes deep problems as the country can face higher inflation due to an internal supply that no longer satisfies the demand and an increase in its current account deficit as the country will need to import more to respond to gaps in the supply side.

The government have announced recently measures to tackle those constrains, as offering higher returns for investors to persuade them to build a US$ 93 billion of infrastructure on road projects, ports and rails works. During the 2000’s France enjoyed a high growth, reducing unemployment but failed to undertake structural reforms (pensions, labor market, tax level & structure, public spending…). Unsurprisingly, these reforms proved much harder a few years later. Brazil has to take advantage of its current phase of low unemployment and rising real incomes to tackle its missing points in order to jump-start economic growth.

Monica Vaisman-Pinto, economist.

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