The Future Ain’t What It Used to be in Brazil

Towards the end of 2010, CBS News correspondent Steve Kroft reported on the economic progress of Brazil in a segment aired on “60 Minutes.” The title of that segment was, “Brazil: The Worlds Next Economic Superpower?” It seemed that Brazil had finally figured out the right formula for unleashing the human potential of its 200 million strong population and abundance of natural resources. Lula de Silva was leaving office with enormous popularity in his home country and worldwide respect. The World Cup and Olympic Games were on their way and Brazil was overtaking Britain as the world’s fifth largest economy. It’s well worth revisiting the thirteen-minute piece which you can find on YouTube.

It is a little more than six years later now and the economic and political situation in Brazil could not be worse. During 2015 and 2016 the Brazilian economy contracted at rates of 3.8% and 3.2%. By comparison, 2009 was the worst year of the Great Recession in the United States when the economy contracted by 2.8% and in the previous year the contraction was only 0.1%.

What went so wrong and can Brazil return to the strong growth trajectory they were previously on?

Source: World Bank

 

 

 

 

 

 

 

 

 

 

Lula da Silva was elected President of Brazil in 2002 and he took office in 2003. As a member of The Workers’ Party, many were nervous at the time that da Silva would steer Brazil further into socialist territory in a similar vein as Hugo Chavez had in Venezuela. Instead, da Silva’s policies were much more moderate and he focused instead on protecting a social welfare state within a capitalist system. His chosen successor from The Workers’ Party, Dilma Rousseff, was elected President in 2010 with 56% of the vote.

A large part of the problem facing Brazil was that observers both in Brazil and internationally gave da Silva far too much credit for the growth spurt the country achieved during his Presidency, where the economy grew by more than 4% on average. Some of da Silva’s policies undoubtedly narrowed inequality and aided the emergence of a larger middle class, but the biggest tailwind for the economy during those years was an enormous increase in natural resource prices. Natural resources play a large role in Brazil’s economy. The oil company Petrobras is far and away the largest Brazilian company and other large companies include the iron ore miner Vale. Brazil is the world’s tenth largest oil producer and third largest producer of iron ore.

After the Asian financial crisis in 1997 and subsequent default by the Russian government in 1998, oil prices fell to a low of almost $10 per barrel. Several years later when da Silva became President of Brazil, oil was still selling for only about $20 per barrel. But a combination of factors that included the United States’ war in Iraq and insatiable demand from China caused oil prices to rocket upwards beginning in around 2003 until the price reached about $140 per barrel just before the financial crisis in 2008. Today, oil is still only selling for close to $50 per barrel.

A similar story unfolded with iron ore prices. The price per metric ton of iron ore was only $14 in 2002 but rose to a high of almost $190 per ton in 2011. Today, the price is only about $80.

Source: World Bank

 

 

 

 

 

 

 

 

 

For many years, the percentage of income derived from natural resources in Brazil fluctuated at between 2% and 4%, but at its peak in 2008, this figure rose to almost 8%. When prices for natural resources started tumbling, Rousseff had a problem. She ran for re-election during 2014 and needed a continued strong economy to boost her chances for victory, but without the free-flow of funds from natural resources, there were few levers she could pull. In order to bridge the gap in aggregate demand, Brazil doubled its budget deficit in 2014 to 6% of GDP from 3% in 2013.

Plunging oil revenue also took its toll on Brazil’s trade balance, which in turn cause the Brazilian Real to rapidly lose value.

 

 

 

 

 

 

 

 

This, in turn, kicked up increased inflation in the country and prevented the Central Bank from providing monetary stimulus during this severe recession.

 

 

 

 

 

 

 

 

 

Brazil’s problems, though, much deeper than just a difficult economic experience. Not long into Rousseff’s second term, a corruption scandal ensnared her and ultimately led to impeachment, while also implicating da Silva. Much of the exposed corruption related to bribes accepted at Petrobras from construction and other companies to direct business their way and which occurred while Rousseff was Chairman of the company. Compounding problems, the Rio Olympics, which were intended to showcase Brazil to the world, received tremendous criticism and only showcased how unprepared Brazil was to host them.

Following Rousseff’s impeachment, Michel Temer became President of Brazil and there are some modestly encouraging signs on the economic front. Economists expect that in 2017 Brazil can return to modest GDP growth of about 1%. But, Brazil continues to have structural economic problems hang over its head and needs a more comprehensive strategy aside from waiting for higher commodity prices. Some of these reforms could include a reduction in beuracracy and encouragement for more entrepreneurship in the country.

Temer’s turn runs out in 2018 and da Silva has mulled making another run at the Presidency. Who Brazil decides to elect will go a long way in solidifying the future path the country takes.

 

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