Brazil has come a very long way indeed since the presidential elections eight years ago. Fernando Henrique Cardoso, first as finance minister, then as two-term president (1995-2002), defeated hyper-inflation. However, by the time of the elections, economic stabilisation remained incomplete on at least two accounts: the fiscal adjustment in the aftermath of monetary stabilisation was insufficient; and the political consensus in favor of stability-oriented economic policy was incomplete. The prospect of PT candidate Luiz Inacio (Lula) da Silva winning the elections exposed both weaknesses, triggering the 2002 “transition crisis” that almost pushed Brazil into default. The implementation of a decisive fiscal adjustment and the wholesale preservation of the inflation-targeting regime based on central bank autonomy under Lula not only completed Brazil’s economic adjustment, but it also consolidated the political consensus in favour of economic and financial stability. It also happened to prove to be an astute and very successful political strategy, allowing the PT to make electoral gains in subsequent elections and Lula to be re-elected for a second term in 2006.
This year’s presidential elections, contested by two candidates broadly committed to the existing economic policy consensus, will be a relative non-event from a short-term market point of view.
If PT candidate Dilma Rousseff wins, current macroeconomic policies will remain pretty much unchanged (“dirty float”, 4.5 percent inflation target, primary surpluses large enough to reduce net debt-to-GDP ratio). Rising government revenues on the back of strong economic growth will give the government sufficient flexibility both to increase expenditure in real terms and to maintain primary surpluses large enough to reduce the level of public debt.
If PSDB candidate Jose Serra wins, we may see a slightly tighter fiscal policy (read: more ambitious primary surplus targets). This might bring about lower interest rates and a weaker exchange rate – an objective put forward by Serra on more than one occasion. If tighter fiscal policy fails to achieve this, the big question will become whether a PSDB government would seek to achieve lower interest rates and a weaker exchange rate through direct government intervention. At present, it looks unlikely that Serra would rock the “boat of policy consensus” that has allowed Brazil to maintain course during one of the worst storms in recent memory, not least because the current course enjoys overwhelming political support. It is worth pointing out, however, that a Brazilian president faces relatively few obstacles when it comes to pursuing less disciplined monetary and fiscal policies.
Both presidential candidates believe that the state has an important role to play in economic development. Arguably, a PT administration would be less enthusiastic about liberalizing structural reforms. Otherwise, it would have already implemented them, taking advantage of the president’s incredibly high approval ratings. A “new” Serra government, eager to leave its mark, would no doubt propose a more ambitious reform agenda (e.g. pension, tax reform). Serra is committed to an “efficient” state somewhat more circumscribed in its activities than it is in the vision of the PT. For all practical purposes, however, one ought not to get too excited about the prospect of wide-ranging structural reform under a Serra presidency. The structure of the Brazilian political system is such that it makes wide-ranging structural reform very difficult to implement on account of various “veto players” (e.g. fragmented, difficult-to-control legislature, powerful states, restrictive constitution), no matter how committed a government is to reform. Even under the best of political circumstances, reform will likely be limited and gradual.
What is to be done? The next government should focus its efforts on reforms that are politically achievable and economically effective. As we and others (Hausmann, Pastore) have argued, limited domestic savings are the most important factor constraining growth in Brazil. Therefore, first and foremost, the next government should seek to limit increases in current spending to below the level of nominal GDP growth and ensure that public-sector investment is narrowly focused on projects where the expected social returns exceed (appropriable) private returns. If the government believes that it can muster sufficient congressional support, it should also consider granting the central bank full legal independence and introducing an explicit fiscal rule committing Brazil to public debt reduction – similar to what Turkey has proposed recently, for instance. All of these measures would help boost savings (and investment).
Last year, we revised upwards our estimate of Brazil’s medium-term growth potential to 4.5 percent from 3.25 percent. Brazil needs to take advantage of the favourable global outlook (e.g. commodity prices, increasing oil exports) and strong economic growth momentum to raise domestic savings, thus allowing for a sustained increase in investment without weakening its medium-term external position. If the next government succeeds in implementing a medium-term fiscal adjustment, there is no reason why Brazil won’t be able to achieve 6 percent growth. This might go some way in silencing some of the critics who believe that Brazil does not belong in the BRICs.
Markus Jaeger is a director at Deutsche Bank Research in New York. This column is based on a research memo to clients. Republished with permission.