The beginning of the 21st century was full promise for Brazil. This was going to be the time when the country would move from being an emerging market to the status of developed first world nation, within the first two decades. Economic growth accelerated from 3% in 2002 to 6% by 2007. After a brief interruption as a result of the financial crisis and resulting economic downturn in 2009, growth surged in 2010 approaching 8%. Foreign investment was pouring in. The boom in commodities, was about to bring a general prosperity that had been unseen before, to this continental giant.
In the last 15 years Brazil has catapulted itself to become the 8th largest economy in nominal GDP (Gross Domestic Product). In PPP (Purchasing Power Parity) it is now the 7th largest. The Brazilian economy has grown to be the largest in Latin America and the 2nd largest in the Western Hemisphere, after the United States. From the decade that lasted from 2002 to 2012, the domestic economy grew by an average of 5%. It was one of the fastest growing major markets in the world.
By 2012, Brazil had become the 6th largest global economy by surpassing the United Kingdom. That same year Forbes identified the country as having the 5th highest number of billionaires in the world. This was a far larger number than anywhere else in Latin America and exceeded the number that could be found in either Japan or the United Kingdom.
In 2009, the World Economic Forum considered Brazil to be the leading country in upward evolution of competitiveness. The country had surpassed eight other countries, finally overcoming Russia for the first time. The Brazilians were even able to narrow the gap with China and India.
The government of Brazil had taken important steps in the 1990’s towards achieving fiscal balance, as well as opening the country to outside investment. The efforts to liberalize the economy during this time period, allowed for the subsequent enormous growth in private sector development.
The largest component in the Brazilian GDP is the service sector at 67%, which employs 71% of the working population of some 107 million. The industrial part of the economy comprises 27% of the total and employs 19% of the country’s labor force. Although 10% of Brazilians are engaged in agriculture, the employment generated by this sector is only 5%.
The main industries of the country consist of textiles, apparel, chemicals, cement, lumber, iron ore, tin, oil,steel, aircraft, motor vehicles and accessory parts, machinery and related equipment. These were many of the things China needed, to fuel its rapid expansion during the last few decades. Trade with China soared from the equivalent of $2 billion USD (United States Dollar) in the year 2000, to $83 billion USD in 2013.
Of the nearly $1 trillion USD that foreign investors poured into the emerging world by 2011, when the commodities boom was beginning to peak, Brazil was able to capture a sizable share. Many investors worked with the Brazilian markets, because they were far more transparent than the ones in China. It was a way to invest in Chinese economic growth safely.
Brazil has a population of 198.3 million and is blessed with abundant natural resources. The country has become one of the top ten largest markets in the world. This is especially the case if one considers that the shadow economy that is the untaxed part, is now approaching 40% of the total.
The nominal GDP of Brazil is estimated at $1.903 trillion USD. The GDP in PPP is estimated between $2.4 trillion and $3.59 trillion USD.
In more recent times, growth has slowed to a crawl and finally this year the country headed into recession. What happened to the growth? Well a key to the problem, is the aforementioned shadow economy. Much of the economic activity of the country occurs unofficially, the result of strenuous regulation,unproductive taxation and prolific corruption. It is a situation that resembles Italy, but at a far larger scale.
Structural economic reforms have been slowing for years, but had been masked by the strong growth in commodities during the last decade and a half. The near insatiable appetite by China, kept many of the trade goods offered by Brazil in both full demand and in high price. The boom in commodities throughout Latin America but especially in Brazil, permitted the country to spend enormous sums on both big infrastructure projects and social welfare.
As growth has slowed in China, the demand for raw materials from Brazil is in a corresponding decline. Exports to China have dropped by some 20% so far this year alone. Since the slackening demand for global commodities is across the region many of Brazil’s trading partners are now similarly affected. This has brought the growth in trade to nearly a standstill, not only in South America but throughout most of Latin America.
Brazil was soon experiencing rising unemployment that soon reached 6.6%. It is expected to surpass 8% in 2015. Of course the real rate is much higher, as is the case in many other countries. Inflation that had been tamer in more prosperous years, inched up to an annual rate of 6.2%. The rate so far this year has been 8.2%. At the same time, foreign investment was slowing rapidly and capital flight was already beginning in 2014. The departure of overseas investors is expected to accelerate this year and in 2016.
The situation with slackening demand from China is largely outside the control of Brazil, but the need for broad-based and pursuant reforms, are the only way to bring growth back to a presently deteriorating economic state of affairs.
The government intervention in the economy less noticeable in more abundant times, is causing a misallocation of capital and social mobility. It has fueled a sense of injustice and dissatisfaction among the rising middle class, that has made enormous economic gains over the last two decades. The wealthy are already abandoning Brazil in droves, as they relocate assets and find new residences abroad.
The near collapse in commodity prices has not only led to a reduction in growth, but a similar decline in national investment in necessary public infrastructure and services. Brazilians are left with high taxes, along with rising unemployment and inflation. The acceptance of rampant corruption under these conditions is far less tolerable.
There is unlikely to be an immediate political solution either. The national elections held last October, gave President Dilma Rousseff narrowly, a second term in office. The left-wing Workers Party (PT) she represents, has been in control of the government for the last 12 years. There have already been 3 mass protests against her and the corruption permeating from the present ruling elite. The demands for her impeachment and a change in policy, will only grow as the Brazilian economy continues to stagger downwards.
President Rousseff seems to lack solutions how to turn around an economy facing slowing growth and rapidly rising debt. Her popularity has now sunk to just an 8% approval rating. The country has already received a recent downgrade of its hard won investment credit rating, due to rising government expenditures in the face of an oncoming recession.
Public debt has already risen to 66% of GDP. Not shockingly high when compared to the United States for example at 105%, but the rapid increase is troubling. In 2014, debt payments alone, took more than 6% of the total output of Brazil.
The rising government budget deficit is unlikely to decline very much, in the present economic and political climate. Brazil’s Bolsa Familia cash transfer payments to the poor will continue, as the government is eager to shore up public support during this period of economic contraction. Public spending is now equal to 40.4% of the GDP.
The Brazilian Stock Market is hemorrhaging losses as the recession deepens and the value of the real continues to drop. The present political crisis with charges of corruption and ineptitude only make matters worse, as investors are rapidly losing confidence. Just a few years ago the Brazilian Stock Market was 4 times larger than the nearest rival, which was the country of Mexico. The gap that was once over $1.1 trillion USD, has now narrowed to just $133 billion USD. A number of analysts are already predicting, that the present advantage will disappear in 2016.
The stock market in Brazil is down 22% from last year alone. The Brazilian real has already lost a third of its value in the same time period. The one bright spot for Brazil remaining in this troubled circumstance, is the $371 billion USD worth of foreign exchange reserves held by the Central Bank. However, these funds will be insufficient in a prolonged economic crisis.
The stagnation of the Brazilian economy has deepened over time. Growth averaged just 2.2% during the first term of President Rousseff from 2011 to 2014. This was a slower pace than most countries in Latin America. In comparison to China and India, two other members from the group know as the BRIC it was dismal. Last year growth slowed to a crawl. In 2015, the economy of Brazil is expected to contract by at least 2%.
Household consumption is now registering its first drop since the PT came to power in 2003. The budget deficit has already doubled last year to 6.75% and is likely to rise further. Most troubling for investors is that for the first time since 1997, no money has been allocated to pay back creditors. Brazil’s exceptionally high rate of interest at 13.75%, makes the servicing of debt far costlier to maintain. This is the result of the Brazilian Central Bank attempting to combat inflation, which was about to get out of hand.
Unlike most industrialized countries in the world that are presently experiencing low inflation and therefore near zero interest rates in an effort to stimulate growth, Brazil is having to deal with a spiraling price situation, that is making the government increasingly unpopular. Consumer confidence is rapidly falling to levels, not seen in a decade or more.
Wage growth in Brazil has grown faster than productivity for the past decade. This encouraged more borrowing and spending than the economy could support, without a rise in inflation. Real wages have already peaked and have been falling since March of this year. Disposal income is already taking a hit, as consumers are being forced to use increasing amounts of cash to pay back previous loans.
The high wages along with overly aggressive government regulation, and a previously strong currency as well as poor public infrastructure, has made Brazilian industry quite noncompetitive in the global marketplace. The domestic demand for cars for example, is down 20% this year already. Worst yet, the giant state controlled oil company Petrobas, which is the biggest source of investment and extra revenue for the government, is in the midst of a huge corruption scandal. It is now estimated that at least $2 billion USD, has been stolen in the last decade alone. This situation has clearly effected revenues and expenditures of the company, that might in the end reduce the GDP of Brazil by a whopping 1% this year.
In order not to lose the highly valued investment credit rating already downgraded to Baa3 from Baa2, the government has been forced to look for savings wherever possible. As a result, Brazil is cutting unemployment insurance at the same time that the rate of joblessness is rising. Benefits are being scaled back, almost across the board.
Taxes are also rising as are fees on fuel, water, electricity and other public utilities. Of course, some of these price hikes will actually help reflect the true cost of many of these necessities, thus reducing demand. As a whole they have long been held in check by the government, to maintain popularity among the voters.
What can the government of Brazil reasonably do in the present juncture? If there is an attempt to use fiscal stimulus to move the economy forward, there will be an almost immediate downgrade in the present credit rating. The Central Bank might be tempted to ease monetary policy again, by lowering interest rates. That would fuel further inflation and weaken the currency. The real is already the worst performing major currency in the world this year. It would also make the foreign debt of $230 billion USD, increasingly harder to manage.
The only way out at this point, is further and more far reaching economic reforms. The question is, will these improvements occur fast enough to turn the economy around, before the patience of the Brazilian people eventually runs out? Given the present sluggish growth internationally and with the continuing depressed market for most commodities, that seems highly unlikely. Will Brazil once again, return to being the country with a bright future, that never seems to arrive.