Friday, March 6, 2015

Brazil - Challenging times

Having written recently on the economic resurgence underway in India, it seems only fair to compare and contrast with another large emerging economy where the economic environment is more challenging.  So let’s have a look at Brazil.  This is made more timely with the decision this week by the interest rate setting committee of the central bank (COPOM) to raise interest rates despite the poor growth environment.

2014 was a challenging year for the Brazil economy with growth coming in at an estimated annual average 0% for the calendar year.  Into 2015 the headwinds are increasing.  A combination of fiscal tightening, higher interest rates, low business and consumer confidence and the possibility of power rationing later this year will conspire to keep growth low in the foreseeable future with recession a possibility in 2015.

Like India, Brazil was one of the fragile five in 2013.  The Real has depreciated 20% since its peak in 2011 and should be a boost to the external sector and growth generally but the current account deficit is yet to improve.  

Gains in competitiveness are most helpful to manufactured exports and Brazil has a relatively low share of manufactures as a share of total merchandise exports at 36% (2013 data from the Word Bank).  That compares with 62% in India and 94% in China.  Weak commodity prices along with soft external markets are proving to be a drag on any improvement in Brazil’s external position.

Inflation remains problematic largely thanks to the currency depreciation.  That said the annual inflation rate at 7.1% for the year to January has only just moved out of the top end of the central bank’s target band (4.5% +/- 2%).  We expect it will move higher still in the next few months.  COPOM has raised the benchmark Selic rate from a low of 7.25% in 2012 to 12.75% currently to help keep inflation expectations in check.  Further interest rate increases appear likely.

 After a tumultuous election campaign Dilma Rousseff was re-elected President at the end of 2014.  She has appointed Joaquim Levy Finance Minister.  One of his first jobs is to rein in the first primary budget deficit in 2014 since the mid-1990s.  A number of tax and spending measures have been introduced to turn the Government’s finances around.  This will also have a negative impact on growth and is also adding to inflation through higher charges.

The challenges facing Brazil are difficult but not insurmountable.  Like many emerging economies its demographics are favourable, although not as good as India’s.  The United Nations is projecting strong growth in Brazil’s working age population over the next decade before its starts to level off from about 2025.  As with India higher productivity via stronger investment is the other part of the growth equation.  In terms of an investment friendly business environment, Brazil is on the back foot.

Brazil’s starting point today is higher per capita GDP than both India and China.  Over the last few years a significant proportion of Brazil’s population has moved into the middle class.  Failure to raise productivity and keep inflation in check risks pushing the new middle calls back into poverty.

Ms. Rousseff is making the right noises about reform and the appointment of Mr Levy into the finance role is a positive move.  The right polices, implemented quickly, could soon see Brazil back to sustained GDP growth of 3.0-3.5% per annum.