Brazil – economic backdrop to a country in recession

In less than eight months, Brazil will host the 2016 Summer Olympics at a cost of $11bn. But with weekly protests on São Paulo’s main street, Avenida Paulista, it seems these games can’t come fast enough for Brazil’s president, Dilma Rousseff.

Just under a year ago, the Workers Party President, who has a strong emphasis on social programs was voted in for a second term. However, since her re-election Latin America’s largest economy has plunged into recession.

In 2010, Brazil was enjoying 7.6% GDP growth, making it the world’s seventh largest economy. But since president Lula da Silva left office five years ago, Brazil has experienced a major economic downturn.

The country was once among the fastest growing large economies in the world, booming at China-like growth rates. This year its economy is predicted to shrink by 2.8% and next year it is expected to suffer a further 1% contraction.

Corruption

To make matters worse for Rousseff, Brazil is experiencing one of the worst corruption scandals in the country’s history. An investigation of state-controlled oil company Petrobras has seen its stock fall by 60% over the past year, and the company has had to write off $2 billion in bribery-related costs.

Unemployment now runs at about 7% and is increasing, while Brazil’s high interest rates of around 14% are making borrowing costlier to service. And with a large amount of the national debt in US dollars, the recent devaluation of the currency means that the amount to be repaid has significantly increased.

There doesn’t seem to be any light at the end of the tunnel for the 204m Brazilians, particularly the 55% termed as middle class. According to the Government, if you earn anything from 291 Brazilian Real (BRL) to BRL1,019 (€90 - €300) a month in Brazil, then you’re middle class.

And the recession is projected to continue into 2016, due to much needed fiscal adjustment, tighter monetary policy to contain inflation and a lack of investor confidence related to the political uncertainty. Some economists believe that a slow recovery will unfold by 2017 as confidence in macroeconomic policies improves. Right now this is hard to see.

Economic policy

So what went wrong? The three pillars supporting economic policy between 1998 and 2006 were strict fiscal targets, an inflation targeting system and flexible exchange rates.

This model persistently reduced inflation and interest rates, simultaneously leading to a flexible exchange rate system. The strict fiscal control and economic growth ensured national debt reduction and therefore secured reduced interest rates and increased public and private investments.

However, from 2006 onwards those pillars gradually changed. The economic policy focused on fostering demand without fostering competitiveness as a whole. It was hoped that this strategy would deliver demand incentives and create a favourable environment for investments, which would in turn, create economic growth. However, the economy grew only until full employment was achieved and investments never came.

The government is now trying to incentivize consumption and this is fuelling inflation which is running dangerously close to double digits at present (9.93%). Something Brazilians are all too familiar with having seen inflation spiral and reach an annual level of nearly 5,000% at the end of 1993. This was curbed by the introduction of the Real (BRL) currency in 1994 and by 1998 inflation rates fell to a low of 2.5%.

Uncompetitive

Red tape, poor infrastructure and a strong currency (up to now) have rendered much of the economy uncompetitive. Therefore consumers have been the main source of demand. A low unemployment rate has pushed up wages. In the past ten years wages in the private sector have grown faster than GDP (public sector workers have done even better). That allowed consumers to borrow more, which encouraged still more spending.

In order to keep inflation rates from rising further, economic policies are keeping prices of various products under government control artificially low, such as electricity and petrol.

Coupled to this, its currency crashed to an all time low against the dollar last month on concerns over the fiscal management and political uncertainty. In the past, one US Dollar bought BRL2.5, today it buys BRL4. As the largest producer of sugar cane and the second largest producer of cattle and soyabean in the world, this is boosting exports from Brazil and farmers are feeling the benefit. But it is making everything from clothes to fertiliser and machinery, that must be imported, much more expensive.

Brazil, as Latin America's largest country and the fifth most populated in the world (only Russia, Canada, China, and the US are larger), clearly impacts the global economy. The country’s plans for the next decade may not just depend on the economic policy adopted over the next five years but is more likely to depend on whether Rousseff will still be in power in 12 months time.

More coverage on Brazilian agriculture to follow at Farmersjournal.ie and in the Irish Farmers Journal.