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Brazil: Forget the Reforms

Unlike the other members of the BRIC community, Brazil is not enjoying record GDP growth rates. Brazil’s unemployment rate is in the double digits, and it is about to get worse


Tax reforms, labor reforms, and further progress on the pension reforms. These legislative initiatives are on hold for the foreseeable future… and no one seems to care. The Brazilian economy is doing well. Exports are growing, and the trade surplus is expected to remain above $40 billion. Foreign investment is pouring in, with disbursements of $16 billion estimated for 2006. The government will report a primary surplus of more than 4.2% of GDP. Brazil’s inflation rate is below the 4.5% target that was set for this year. The pace of economic activity is running well ahead of last year’s level, and almost twice as high as the average growth rate for Lula’s first term in office. Brazil’s debt stock is declining in real and nominal terms, as well as the government’s level of foreign indebtedness. Given these conditions, it is little wonder why most people are impervious to the lack of progress on the reform front.

On the domestic front, most Brazilians are pleased with the government’s performance. The polls suggest that Lula should win in the first round. The latest Sensus poll showed Lula with 51.4% of the vote, up from 47.9% at the beginning of August. Geraldo Alckmin had only 19.6%. Lula’s lead was helped by a 15.1% boost in government spending during the first half of the year. Most of the expenditure increase was directed at social assistance programs and infrastructure projects. A 75% increase in the minimum wage was also well received. All of this suggests that the presidential election should become a non-event.


On the external front, investors are piling into Brazil as one of the components of the global realignment strategy. One of the four BRICs, Brazil is a mandatory destination in the emerging market universe. Once considered an esoteric asset class, the emerging markets are now an important part of the global asset allocation mix. Not only is Brazil one of the dominant players across the major commodity groups, it offers double-digit yields on local currency instruments—making it one of the most attractive alternatives in the asset class. In other words, Brazil’s macroeconomic management is not the reason it is so attractive. Brazil is purely a global macro play. The performance of the Brazilian economy is a reflection of the global environment. It has nothing to do with domestic conditions. On the contrary, the mismanagement of the Brazilian economy is what makes it so interesting.

The Brazilian government’s failure to implement the reforms is the reason why inflationary pressures lurk so close to the surface, that the central bank must constantly keep both feet on the monetary brake. The Brazilian government must take steps to increase productivity and improve efficiency. It needs to remove the structural impediments that spark inflationary pressures whenever the pace of economic activity accelerates beyond 5%. Failure to do so means that the central bank must keep real interest rates very high. The tight monetary stance creates a drag on the fiscal accounts, reducing the government’s ability to direct more resources towards education and health. It also puts upward pressure on the currency. These three conditions, which are double digit interest rates, an appreciating currency and a government coffer that is brimming with cash, are an absolute dream for investors.  


The internal and external environments are allowing Lula to waltz back into office and investors to make a tidy profit. However, someone always pays the price, and in this case it is the Brazilian population. Unlike the other members of the BRIC community, Brazil is not enjoying record GDP growth rates. Brazil’s unemployment rate is in the double digits, and it is about to get worse. The deindustrialization of the Brazilian economy, thanks to the appreciation of the Real and the shift to commodity production, is increasing the unemployment rate. Brazilian consumers and small business owners are also paying the price, by being force to live with double and triple digit interest rates. These economic conditions explain why Brazil has one of the highest illiteracy rates in Latin America, soaring infant mortality rates and chronic crime epidemics. As long as the global environment remains the same, most investors will not care if the Brazilian government ever implements the reforms. On the contrary, the reforms would only improve the country’s credit conditions and drive down yields. However, Brazilians should care, because they are the ones left holding the bill.

Walter Molano is head of research at BCP Securities.

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