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Brazil’s Economic Meltdown and its Causes
August 26, 2017
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About seven years ago, at the end of the global financial crisis that hit in 2007, things were on the up and up for Brazil. It discovered large oil resources in a short span of 2 years. It was set to become a global force to be reckoned with, owing to its oil resources. It also developed a large commodities market. It exported iron ore, raw sugar, soya and coffee, among other agricultural products.  The left-wing, progressive party had been at the forefront of growth and development in Brazil since 2002. Brazil became one of the fastest growing economies in the world at the turn of the century. The growth rates averaged at 5% p.a. between 2002 and 2012. It is still the seventh largest economy in the world in terms of purchasing power parity. It made a lot of strides in human development and inequality reduction under the Worker’s Party administration. Most of the headlines in recent weeks have focused on Brazil’s troubling political crisis. But the country is also in the midst of a deep economic recession. The economy has been shrinking since the second quarter of 2014. It contracted by 3.8% in 2015 and is expected to shrink by a similar amount this year. Earlier this month, the Organisation for Economic Co-operation and Development (OECD) said it sees the recession continuing into 2017.

Yet it was only in 2009 – in the middle of the global financial crisis – that the Economist magazine featured a story entitled “Brazil takes off,” with a photo of the Corcovado – the iconic statue of Christ that overlooks Rio de Janeiro – launching like a rocket. That article emphasised why Brazil deserved to be one of the “BRICs” – the rapidly growing economies including Russia, India and China that now account for nearly 25% of global gross domestic product (GDP).

How could the outlook for Brazil have changed so rapidly? Is this sort of boom and bust unprecedented or a recurring theme in Brazil’s history? In this article, we provide a historical perspective on the current economic crisis, relying on our own scholarship and years of analysis of the Brazilian economy.

Brazil arrives

Brazil has been knocking at the door of the developed world for quite some time. It has been dubbed the “country of the future” since Stefan Zweig coined the phrase in the title of his 1941 book. And that future seemed attainable.

From 1900 to 1980, Brazil had one of the fastest-growing economies in the world. Income per capita rose faster in Brazil than in the US. The country was transformed from a rural, agricultural economy – producing coffee, sugar and other products for export – into an urban, industrial powerhouse.

Yet a closer look at Brazilian economic history reveals frequent cycles of boom and bust, where considerable optimism fell by the wayside, leaving behind unfulfilled dreams. The future, it seems, has always been just around the corner.

Several analysts in Brazil have begun to repeat the claim that the current recession is likely to be worse than what Brazil faced in the 1930s. While technically correct, in our view, this is not the appropriate comparison.

Brazil did quite well in the 1930s relative to many other countries. After growing at over 10% a year in 1927 and 1928, the Brazilian economy only contracted in 1930 and 1931. The recession was then followed by eight years of fairly robust growth.

The 1980s and early 1990s were a much more painful time in Brazil, following a particularly potent boom known as the “Brazilian Miracle.” We return to a comparison with this period below.

State-led industrialisation and the ‘Brazilian Miracle’

Following World War II, Brazil’s federal government began to plan for economic development and target industrialisation and high rates of growth.

Juscelino Kubitschek became president in 1956 and promised to deliver “50 years of progress in five.” This was a period of immense optimism, and Brazil seemed like an endless construction site, with highways, buildings and industries popping up throughout the country.

As a symbol of this progress, Brasilia was inaugurated in 1960 as a planned capital city with a modernist architecture. Yet the optimism of the 1950s quickly gave way to the political turmoil of the early 1960s.

When Jsnio Quadros abruptly resigned from the presidency in 1961, the left-leaning Vice President Joao Goulart took office. His support of labour rights, land reform and other populist policies led to his removal by the military in a 1964 coup, with the support of the Brazilian elite and US government. The generals would run the country until 1985.

Brazilian democracy and a more inclusive model of development were the principal victims. Growth, in contrast, quickly resumed, and this contributed to rapid poverty reduction. In what became known as the Brazilian Miracle, real GDP expanded at over 8% annually in every year but one from 1968 to 1976. Poverty fell by over 20 percentage points from 1960 to 1980, even while income inequality continued to rise.

What went wrong

Unlike with the slowdowns of the 1930s and mid-1960s, the depth and length of the economic crisis of the 1980s were much more severe.

The global economy had changed in the 1970s and Brazil was slow to adapt. It relied on foreign debt to prolong the inward-looking industrialisation model that had worked so well for decades, but this too came to an end in 1982 when a debt crisis erupted throughout Latin America.

The optimism of the miracle years would be replaced by stagnation and hyperinflation. From 1981 to 1992, the economy experienced negative annual growth in five separate years, and annual inflation soared into the thousands. Income per capita peaked in 1980 and would only permanently surpass this level again in 1994.

This was a “lost decade” for Brazil in terms of living standards, but popular discontent forced the military to exit power in 1985 and led to the writing of a new Constitution in 1988.

However, the hope turned to ashes in 2014 when Brazil entered a recession, after a 2013 slowdown. The economy contracted by 0.3% in the last quarter of 2014 and by about 3.8% in 2015. Inflation is also considerably high at 11% and unemployment rate for the same period was 9.5%. The extent of government debt in the last quarter of fiscal year 2015-16 was about 67% of the GDP. The primary deficit stood at 10% of the GDP.

Back to boom

The foundations for the most recent cycle of growth and optimism were laid from 1994 to 2002. First, after numerous failed attempts, in 1994 the government finally devised a stabilisation plan – the Real Plan – that succeeded in defeating hyperinflation. Then, from 1995 to 2002, a number of important policies were adopted under President Henrique Cardoso. These included a modest reform of the public sector social security system, the creation of an anti-poverty conditional cash transfer program tied to kids going to school and the adoption of an important fiscal responsibility law that – 15 years later – would be used to justify removing President Dilma Rousseff from office.

Cardoso also made progress in adopting more sound macroeconomic policies as he let the exchange rate float in 1999 and then instituted a system of inflation and fiscal targets. While this was a period of slow growth and international turbulence, inequality began to decline for the first time in at least 30 years.

Luiz Inacio Lula da Silva pursued similar macroeconomic policies during his presidency from 2003 to 2010, reformed the social security system and transformed and expanded the anti-poverty policies. With a much more favourable international environment, until 2009, and a strong commodity boom, the economy expanded at around 4% per year, and poverty declined by around one-third. This was the first time in at least 50 years that Brazil simultaneously experienced growth and a reduction in both poverty and inequality.

With rising living standards and falling poverty, Brazil once again entered a phase of considerable optimism. As Brazil paid off its debt with the International Monetary Fund (IMF), the country began to discover large reserves of oil. International rating agencies elevated the classification of Brazilian foreign debt from speculative to investment grade, clearing the way for the US pension funds to invest in Brazil. Among Brazilian policymakers, it became common to talk of  “sustainable development.”

The optimism only intensified when in 2007 Brazil was chosen to host the 2014 World Cup and the 2016 Summer Olympics two years later – in the middle of the global financial crisis. Brazil was awarded the 2014 FIFA world cup along with the 2016 Summer Olympics. Brazil’s debutante ball quickly became a fiasco as it hit one of the most resilient recessions in its history, coupled with political turmoil. The roots of the recession lie on the export oriented growth model followed by the economy. Brazil in the first decade of the century was heavily dependent on Chinese export demand for iron ore, soya and sugar. During this decade, the commodity prices remained high because of rapid economic growth in China. However, by 2014, the Chinese economy had started to slow down.

In the face of slowing demand, monetary policy remained expansionary, pumping credit into the economy. Concessionary loans were made to the public sector, as well as the private sector. This however, did not lead to fruitful investment. Loans were made without accounting for the risk, the money was not put to good use. This only served to increase the rate of inflation along with a short-lived revival in demand.

Also, oil discoveries attracted foreign capital inflows. At the time of the discovery of Tupi oil fields in 2007, the international prices US $100 per barrel but by the end of 2014, the oil prices fell to US $40 per barrel. Most of the oil fields in Brazil are pre-salt, that is oil-fields are located beneath a thick layer of salt. The state-owned oil company Petrobras has a monopoly over the development of pre-salt oil-fields. They were highly sought after before the oil slump, so Petrobras attracted a lot of foreign capital. Now, the oil giant is riddled with debt. It does not have the necessary cash flows to explore further. The company secured a US $ 10 billion loan from the China Development Bank in exchange for oil supplies. Good old friend China to the rescue!

Things were further complicated because of the political scandal involving the Worker’s Party and Petrobras. Many politicians have been suspected of corruption in conjunction with Petrobras. Dilma Rousseff, herself is facing allegations of bribery, tax evasion and manipulation of company accounts. She will now face an impeachment trial, with the Vice President Michael Temer acting as interim president. Approval ratings of the government were extremely low when Rousseff was removed. His term also got off to a bumpy start with three ministers resigning on account of corruption allegations and the questions of his involvement in the scandal.

The global sentiment is one of skepticism. The new administration has to grapple with seemingly contradictory goals. Reducing unemployment on the one hand and cutting down government spending to reduce public debt on the other. Promised austerity measures appear difficult to implement in a country where one in five people are employed. The deficit target was increased from 1% of the GDP to about 2.5%, if anything, it is the opposite of austerity. However, cutting down public jobs would feed into public dissent when the disapproval ratings are as high as 65%. Much to the relief of the public, Bolsa Familia would also be continued under the new administration.

The statistics indicate a slight recovery in the GDP, the growth rate for the first quarter of 2016 was -0.3% compared with -1.3% in the last quarter of 2015. The exports also grew at around 6.5% in comparison with 0.1% in the preceding quarter. The unemployment rate, however, has increased from 10.9% to about 11.3% in June 2016. The economy is still in considerably bad state and corruption rampant. The economy would have to reduce the budget deficits which at 10% of the GDP is extremely high.

The Brazilian economy has been experiencing busts and booms regularly ever since its independence from Portugal in 1822. It is true that it has made important strides in human development, it still has a multitude of structural weaknesses which need to be addressed. Some of these include rampant tax evasion, an existence of a large informal sector, poor infrastructure, and lack of affordable housing, low domestic demand as well as public sector inefficiencies.  Reliance on oil exports is highly unsustainable. The neighbouring Venezuela serves as an example. The land of sprawling favelas needs to tackle these issues to sustain growth in the long run.

The motto of Brazil is “Ordem e Progresso” which translates into order and progress. This is exactly what it needs, order and progress.

Images: Shutterstock

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