Brazil, one of the world’s most promising emerging economies, is struggling to grow. Decelerating private consumption and demand for exports, as well as structural bottlenecks, are limiting Brazil’s performance. As a result, in June 2013, Standard & Poor’s cut the outlook on the country’s sovereign debt from “stable” to “negative,” citing Brazil’s low growth prospects, weakening fiscal balances, and loss of standing among investors. Public protests that erupted in June have only added to the country’s list of challenges.
Lackluster private consumption and exports weigh on economic growth
Brazil’s economy grew just 0.9 percent in 2012, and it is unlikely to experience a robust recovery this year. Given decelerating private consumption and weak export demand, Q1 GDP growth of 1.9 percent year-over-year fell short of an expected 2.3 percent. Consumer purchasing power has been restricted by high inflation, which has exceeded 6.0 percent since the beginning of this year. Meanwhile, exports have been adversely affected by a slowdown in major markets such as China and Europe (see figure 1). Given slowing demand—both domestic and external—there has been a 2.9 percent year-over-year increase in the number of business bankruptcies in the first five months of 2013. Sentiments about business prospects in the short term are not very optimistic either; the manufacturing purchasing managers’ index hit 50.4 in May, its lowest level in seven months.
Figure 1. Change in real GDP, private consumption, fixed investment, and exports (% YoY)
To help revive private consumption, in June 2013, the government announced BRL 18.7 billion worth of subsidized loans to low-income families to purchase furniture and home appliances. This follows a BRL 2.2 billion tax cut announced in April 2013 to boost car sales. Policymakers are also expected to allow the Brazilian real to weaken against the dollar to support exporters. However, these measures may not be sufficient since private consumption is only projected to grow by 2.8 percent in 2013—the slowest in a decade. Meanwhile, exports are expected to grow a modest 1.3 percent this year. As a result, Brazil’s GDP growth forecast for 2013 dropped to 3.0 percent—down from the International Monetary Fund’s initial estimates of 4. 6 percent.
Inflation to remain high despite monetary tightening
Inflation has been edging up since mid-2012, and in March 2013, it breached the upper limit of the Central Bank of Brazil’s target range of 4.5–6.5 percent (see figure 2). The stubborn inflation is being propped up in part by rising wages, pushed up by workforce shortages and labor regulation rigidities. In the past three years, real wages have increased an average 5.4 percent annually. Furthermore, labor shortages have adversely affected the non-export-oriented segment of Brazilian agriculture, increasing food prices sharply. Continued double-digit credit growth is also likely driving up inflation.
Figure 2. Inflation and interest rates (%)
To curb inflation, the Central Bank has embarked on monetary tightening, raising the benchmark interest rate to 8.0 percent in May 2013 from 7.25 percent in March 2013. The tightening cycle will continue with the rate now likely to reach up to 9.0 percent by the end of the year. Meanwhile, to stem price rise, the government announced BRL 7.4 billion worth of tax breaks on food and other staple goods in March. However, in the absence of structural changes in the labor market, price pressures are not likely to ease with inflation expected to average 6.3 percent this year.
Brazil’s GDP growth forecast for 2013 dropped to 3.0 percent—down from the International Monetary Fund’s initial estimates of 4. 6 percent.
Volatile and interventionist public policy threaten Brazil’s economic strength
At a sector level, government intervention in bank lending has resulted in a shrinking market share for private banks, as public sector banks aggressively expand credit in line with federal directives. In the oil and gas sector, increasing government control of resources and delays in settling a royalty sharing dispute among states has hampered new investments. Auctions held in May 2013 for oil and gas block rights were the first in five years. Similarly, delays in mining reforms have reportedly resulted in companies deferring $20–75 billion in investments for the 2012–2016 period.
At the macroeconomic level, while government stimulus is unlikely to significantly increase private consumption, it may be stoking price rise. On the other hand, the tax breaks to stem rising prices may not dramatically lower inflation in 2013, but they would contribute to a higher fiscal deficit of 2.8 percent of GDP in 2013, up from 2.4 percent in 2012. Meanwhile, even though the government is content to allow the real to depreciate, this might not be enough to boost exports. Instead, a falling real would raise import costs, thereby pushing up inflation and denting the current account. The current account deficit for 2013 is projected at 3.0 percent of GDP, up from 2.4 percent in 2012.
Addressing long-term challenges: Infrastructure and the labor market
Transportation bottlenecks as well as a tight and rigid labor market are limiting Brazil’s competitiveness across sectors. To improve transportation, the government plans to increase investments in areas such as ports, roads, railways, and airports. However, attracting private investors to these projects has been tough, given the low rate of returns initially offered by the government. In addition, the projects have been facing political delays. Brazil also continues to face a shortage of adequately skilled workers. This, in addition to rigid labor laws, has been lowering competitiveness in various sectors.
Public dissatisfaction over the state of affairs in the country, including deteriorating public services, increasing corruption, and rising prices took the form of widespread street protests in June 2013. To placate the public, President Dilma Rousseff promised to enhance public transportation, use oil royalties to improve education, and draft doctors from overseas to boost health care. However, protests continue, albeit at a smaller scale, over corruption issues. This is probably indicative of the larger challenge for Brazil, where immense economic potential is limited more by internal weaknesses than external factors.