The worldwide reports marking Brazil as ground zero of the mosquito-borne Zika virus, linked to the birth defect microcephaly, could hardly have come at a worse time for this country. It was not that long ago that Brazil still headed the acronym BRICS for places that put in admirable and promising economic performances. Real GDP boomed upwards at a real 7.5% in 2010. Inflation seemed under reasonable control. The investment outlook was brilliant, not least thanks to the discovery of rich offshore oil deposits. Construction for the soccer world championship in 2014 was brisk and building activity for this year’s Olympic Games was just getting underway. Above all, global, and particularly Chinese, demand for Brazilian raw materials was red hot and exports were impressively strong.
Switch forward to the beginning of 2016 and you no longer find even a trace of the strident optimism that used to mark the business climate. In 2015, real gross domestic product contracted sharply, with a year-to-year plunge of 4.5% in the third quarter, the sixth consecutive drop and the worst since modern records began in 1996. A further cave-in looks like a safe prediction for 2016. Inflation has shot above 10%, weighing in at 10.67% for 2015 according to the IPCA consumer price index, which is more than four percentage points above the Central Bank’s target range. At about 70% of GDP the national debt is worryingly large for a middle-income country and it is rising fast. Since the benchmark SELIC interest rate (the Brazilian Central Bank’s Sistema Especial de Liquidação e Custodia (SELIC) or Special Clearance and Escrow System) is already standing at a dizzying 14.25%, the cost of servicing it comes to a crushing 7% of GDP.
The fiscal deficit, at over 10% of GDP the largest among emerging economies except for Saudi Arabia, is continuing to grow by leaps and bounds while President Dilma Rousseff’s pleas to the legislators to hike taxes (especially to reintroduce that on financial transactions, the CPMF) have been falling on deaf ears. Standard & Poor’s downgraded Brazil’s credit rating last September, followed by Fitch in December. Industry is reporting a contraction, as are services. Consumer and business confidence has plummeted, spurring worker layoffs and investment cut-backs. Brazilians are now talking about the darkness at the end of the tunnel. The sour mood is reinforced by the fact that towns and cities across Brazil, from Campinas to Porto Ferreira, Macapa and Lavras do Sul, have been forced by a financial squeeze to scrap the traditional five-day carnival celebration.
The problem is that President Rousseff in her first term used a slew of stimulus measures, including price controls and tax measures for industry, to counter the effects of the weakening of demand for Brazil’s commodity exports. The mismanagement and overspending had its consequences, and when she narrowly won a second term in 2014 by vowing to defend Brazilians’ jobs, living standards and welfare benefits from the dastardly machinations of a neoliberal opposition it was clear from the outset that this was whistling in the dark by a President diminished to a popular approval rating of under 10%.
The worries about the national debt can be overdone, to be sure. Most of it is owed to domestic investors and denominated in reais, the modern real. This means much can be inflated away. Other than that, though, there is now no doubt that in the foreseeable future business conditions will continue to go from bad to worse. With China hardly on the brink of a new boom and much of the rest of the world in a funk, demand for Brazil’s raw materials will remain subdued. There is virtually no chance of a vigorous and sustained rise in global oil prices, which is to say there will be little international interest in investment in the pre-salt deposits offshore. The investment triggered by the approach of the Olympics is already petering out, and, while the Games scheduled for August would ordinarily be expected to give a noticeable and sustained boost to tourism, this is now apt to be largely counteracted by the impact of the news surrounding the fast-spreading Zika virus.
There is a distinct risk that Ms. Rousseff will push for a looser monetary policy to pull the economy out of the mire, but with inflation and interest rates as high as they are, the Central Bank has very little elbowroom for making such maneuvers safely. Fiscal results will continue to worsen as revenues keep receding and a huge chunk (close to 90%) of spending is mandated by law, in many cases even by the constitution. There is virtually no chance that the unwieldy pension system will be changed, which has women typically retiring at age 50 and men at 55, nearly a decade earlier than the OECD average.
Nor will President Rousseff be able to tackle the country’s ungainly tax code or bring in any other pro-business measures that would be effective. One of her problems is a political system under which 28 different parties are represented in Congress and party-discipline is virtually non-existent, so that vote-buying in its various forms is rife. When the governing Workers’ Party was under strong leadership, the majority of the parties were only too happy to partner with the government. Also, Ms. Rousseff’s predecessor, Lula da Silva, had the political knack needed to bridge ideological gaps and get people together so that legislation could pass. Ms. Rousseff lacks these skills and has much more difficulty seeking to deal with party fragmentation and political mercenaries. The lawmakers find her weak and in political jeopardy and are deserting what they view as a sinking ship.
Her other problem is a gargantuan bribery scandal surrounding Petrobras. So far, no evidence has come to light that has her directly involved in the debacle, but she was at the helm of the oil company at the critical time and finds it difficult to avoid sharing responsibility. She is also facing charges of cooking the fiscal books in order to make the deficit appear far smaller than it is. Impeachment proceedings against her were initiated in December by the embattled speaker of the Lower House of Congress. But with the body currently in recess until after the carnival, the issue could be looming quite a bit longer, preoccupying the political class while it should be working on ways to energize the economy.
In the background, the US Federal Reserve with its uncertain signals about the future of US monetary policy and US interest rates, has been contributing to a serious drop in the exchange value of the real. This may, down the road, help Brazilian exporters of manufactured goods. But it will not do much for those selling commodities (traditionally traded in dollars).
Ms. Rousseff may still summon enough political support to avoid impeachment, but everything is now in flux. There are essentially three scenarios that could play out. One has her government coping with the worst of the political difficulties and muddling through. In this case the country would lack clear leadership from either the President or Congress. Much of the responsibility for guiding the economy would rest on the shoulders of the Central Bank, which would point toward rising interest rates and unemployment, but also rising inflation. In scenario number two, Congress forces the President out of office (or she resigns first) and this leads to the installment of a responsible new leader determined to strengthen the fiscus while maintaining essential safety nets for those needing them. This is the least likely to unfold. A third possibility, certainly not unthinkable in Brazil, would be the emergence of a populist leader who gathers support and winds up winning the elections in 2018, a personage who promises the world but delivers very little. Such a turn of events could bring a return to the economic volatility and the hyperinflation of the 1980s. In any event, the outlook for the current year is for another drop of real GDP (conceivably again surpassing 3%), for double-digit inflation, and for a rising bankruptcy rate, especially among small and medium-sized companies.