As a corruption scandal rumbles on, Brazil struggles to emerge from recession. Where's a commodity boom when you need one?by George Magnus / June 6, 2017 / Leave a comment
Where’s a decent commodity price boom when you need one? This question may be on the minds of a number of Brazilian politicians, as well as investors, as the country struggles to emerge from its deepest ever recession, and the deadweight of a long-running corruption scandal hovers over President Michel Temer. You may recall that he took over from Dilma Rousseff last year, after she was suspended, pending impeachment proceedings. When the Brazilian Senate voted overwhelmingly to impeach last summer, she was forced step down, leaving Mr. Temer as President until the next scheduled elections in 2018. So, is Brazil out of the woods, finally?
Last week, the statistical authorities announced that Brazil’s GDP had grown by 1 per cent in the first quarter of 2017, compared with the previous quarter. This was the first positive reading since 2014. In 2015, the economy shrank by 3.8 per cent, and in 2016 by 3.6 were cent. On the face of it, this was indeed a shot in the arm, and it followed a year in which Brazil’s financial markets have been on good form. The Bovespa equity market index rose by 80 per cent from depressed levels in January 2016 until mid-May this year, and the Brazilian Real rose by 22 per cent from January last year until October, before stabilising.
Markets were buoyed by the change in political leadership, in spite of the widespread reach of the corruption scandal’s allegations—including to the new President. Yet, he promised to crack on with budgetary reforms, including a 20-year freeze on inflation-adjusted public spending, and overdue pension system and retirement age reforms. He also vowed to remove business red-tape and bureaucracy, sell off infrastructure assets, revise bankruptcy legislation, and open up Brazil’s oil sector to foreign investors.
You can understand, then, why government ministers and the central bank greeted the first quarter’s GDP report with such enthusiasm, claiming the worst is over for the economy. The governor of the central bank went so far as to opine that by the end of 2017, the economy would be back on a 3 per cent growth path. Unfortunately, this looks hugely optimistic. Brazil’s best hope is to achieve an L-shaped economic trajectory, or, with luck, very weak growth. The economy is not yet in great shape, and the long shadows of the Lava Jato, or Car Wash, corruption scandal threaten to engulf Temer’s administration, if not to take down a second president.
That’s why a good old-fashioned commodity boom would be helpful to Brazil at this time. Brazil’s two major growth spurts over the last 50 years or so, from the mid-1960s to 1980, the mid-1990s to 2011, both coincided with strong commodity price booms. They weren’t necessarily the only things that mattered, but they certainly helped to create a strong, conducive backdrop, especially in the 1970s and the 2000s. Yet it doesn’t seem verylikely: though commodity prices have been a bit livelier over the past year, they remain substantially lower than their recent peak levels. With China’s economy slowing down again, after a near two-year stabilisation, the likelihood that Brazil can look to the commodity sector for help is pretty low.
The main driver of the first quarter’s positive GDP report was a 13.4 per cent surge in soy production, thanks to a bumper harvest, but Brazil clearly cannot rely on this as a permanent source of demand expansion. In fact, there are very few signs that domestic demand is poised to recover anytime soon, given that the private sector is in the throes of a major deleveraging. Private sector credit is falling, inflation-adjusted interest rates are still very high—even with last week’s 1 per cent reduction in the main policy interest rate to 10.25 per cent—and total credit advanced to households and companies continues to weaken, undermining the housing market and key consumer sectors, such as automobiles.
If there is any good news here at all, it is that the external deficit in Brazil has been all but eradicated because of the weakness of imports. Foreign direct investment flows into Brazil picked up in 2016 from just over 2 to almost 4 per cent of GDP, and have remained at this level. These developments, then, have helped to anchor the exchange rate. In turn, this has helped to reduce inflation, which has dropped from 9 per cent in the middle of last year to 4.7 per cent in February—the lowest reading for 7 years.
Brazil’s budgetary situation represents a continuing concern over the medium-term. With public debt at about 80 per cent of GDP, and the fiscal deficit still around 9 per cent of GDP, it will take years of cumulative fiscal reform and the return of economic growth to make serious inroads into this heavily structural problem. For now, though, there shouldn’t be any major financing issues, mainly because private sector deleveraging is creating the breathing space for the government to incur deficits without major financial disruption.
Which is where the politics come in. Recent revelations alleging that President Temer had discussed bribes with the former chairman of the Brazilian global meat company JSB, who had taped their conversations, were a reminder that the nation’s corruption scandal knows no bounds. The President is accused of taking substantial illicit payments and discussing how to obstruct the anti-corruption campaign. He has strenuously denied the allegations, but there have been calls for his resignation, or even impeachment. At the very least, it is likely he will face investigations, posing a threat to economic and fiscal reforms, about which financial markets have salivated. Brazil’s economy may have popped out of its 2 year recession, but perhaps only for air. A proper recovery is likely to prove elusive for the time being.