Brazil stumbles after failure to implement fiscal reform

When Brazil avoided the fallout from the financial crisis on 2008, it became a darling of foreign investors desperately seeking somewhere to put their money to work. With an expanding middle class, huge new oil finds and a World Cup and Olympics to host, the South American giant seemed full of potential.

But sustained growth has proved elusive and now the country has been hit by a triple whammy. With the Federal Reserve signalling an end to quantitative easing, many investors have started to pull money out of emerging markets in anticipation of higher returns in the United States. As a result Brazil’s currency, the real, has plummeted.

Despite heavy central bank intervention, the real recently hit a four-year low, stoking fears about inflation which is already at the top of the bank’s range.

The economy has also been hit by the slowdown in China, the country's number one trade partner. Brazil's exports are still heavily concentrated in commodities where prices have fallen as growth in Chinese demand for its foodstuffs and mineral ores tapers off, forcing companies to rethink their investment plans.

Personal insolvencies
Meanwhile, the internal economy looks to have come to the end of a decade-long expansionary cycle driven by consumer demand and fuelled by cheaper credit that followed reforms in the 1990s.

Brazilian shoppers have piled up debts in recent years and many are reluctant to take on more, while banks have reined in lending after a recent jump in personal insolvencies.

As a result, consumer confidence has fallen to levels last seen in 2009 at the height of the global financial crisis while, this year, the São Paulo stock exchange has lost more than a quarter of its dollar value as investors wonder what will drive future growth.

The country is also paying the price for a lack of investment in infrastructure which is not able to cope with the last decade’s growth spurt. City streets are clogged with new cars. The country’s booming agriculture sector sees much of its profit margin eaten up by having to send produce thousands of kilometres on rutted single-lane highways to ports.

Once it gets there it often has to join long lines of trucks waiting to offload cargo onto ships lying idle at sea waiting for berths to become available. In a recent survey by the World Economic Forum, Brazil’s infrastructure ranks 104th out of 142 countries.

Despite a much trumpeted federal investment programme, the government has not managed to lift investment spending above 18 per cent of GDP, well below the emerging market average and short of the 24 per cent investment-to-GDP ratio economists say is necessary to drive sustainable growth of 4 per cent a year.

The government is paying the price for its reluctance to court the private sector as many of the investment projects undertaken by the state have proven disappointing.

Private investors
"As an investor, the state is very inefficient and very slow to make decisions," says Adriano Pires, head of the Brazilian Infrastructure Institute. "If you look at some of its investment programmes, it has not even managed to invest the amount budgeted for it and it has been riddled with scandals."

Having initially shown a reluctance to involve private investors in infrastructure projects, president Dilma Rousseff has signalled a change of course and her government is now auctioning off concessions to run highways, ports, railways and airports to anyone willing to invest in upgrading these services.

But, so far, the results have been mixed as the government has looked to fix returns. At first it offered returns of just 5.5 per cent, too little to attract interest for most projects. That delayed auctions from getting underway as officials revised the rules, eventually upping returns to 7.5 per cent. Weak interest in recent auctions indicates that is also too low to attract desperately-needed investment, potentially putting off a solution to infrastructure bottlenecks.

The failure to resolve the infrastructure problem mirrors a reluctance to create better conditions for the private sector elsewhere in the economy.

Back in 2010, Rousseff brushed off the need for structural reforms to boost growth, brusquely telling reporters during her presidential campaign that an expansion of 7.5 per cent that year proved such painful adjustments were not needed.

Since then the economy has spluttered with growth falling to 2.7 per cent during her first year in power and just 0.9 per cent last year.

A central bank survey of Brazil-based economists predicts growth this year of just 2.2 per cent, though several banks project it will be below 2 per cent.

Now, as global conditions turn unfavourable, the government’s inability to implement reforms in areas such as the judiciary and tax code is holding it back. In a World Bank survey, Brazil ranks 130th out of 185 countries for ease of doing business.

The survey found Brazilian companies require 2,600 hours a year to pay corporate income tax, value added and labour taxes compared to 80 hours in Ireland, while it required 119 days to complete the 13 procedures to set up a business in Brazil compared to 10 days to complete just four procedures in Ireland.

President Rousseff’s failure to seize the structural reform agenda is likely due to her knowledge that pushing such painful changes through Brazil’s fractious congress would exhaust her political capital. With a re-election campaign due next year, she will not undertake them now.

But despite the turbulence and weak forecasts for GDP growth next year, unemployment remains low at just over 5 per cent, with many sectors still reporting difficulties in filling vacancies. Consumers also seem to be digesting the debt they have taken on in recent years. Delinquencies on consumer loans are falling again.

The drop in the currency should help the country’s manufacturers, which have struggled to export in recent years due to the strong real.

Such supports mean most economists predict that Brazil will avoid recession. But with little hope of major domestic reform and the global environment less hospitable, there is little likelihood of an imminent return of the optimism that, until recently, made Brazil a poster boy for emerging markets.