To avoid a nasty hangover, Brazil needs to cut into the bureaucratic fat and frivolous expenses.
BY WALTER T. MOLANO
Today, millions of dancing revellers will clog the streets of Brazil in order to celebrate the start of lent. The cobbled lanes of Lapa and Salvador will be choked with Carnival processions. There is no doubt that Brazilians know how to party. Few countries can ever come close to matching their parades, with their fancy garb, pulsing music and exotic floats. The data released last week by the national statistics agency (IBGE) confirmed that the Brazilian economy had a huge celebration in 2010. It expanded 7.5 percent y/y. This was the highest growth rate in decades, and it confirmed last year’s market optimism. However, a close look at the data revealed a mixed picture. Fixed capital formation increased 21.8 percent y/y, a good sign that investment was an important engine of growth. However, imports greatly outstripped exports, rising 36.2 percent y/y versus 11.5 percent y/y. Moreover, the fourth quarter GDP data had a few unpleasant surprises. The Brazilian economy grew only 0.7 percent y/y, with fixed capital formation expanding only 0.6 percent y/y. In other words, there was a sharp slowdown in economic activity. The only sectors that continued to grow at a faster pace than GDP were household consumption, imports and exports. They grew 2.5 percent, 3.9 percent and 3.6 percent, respectively. The real appreciation of the currency and the continued expansion of consumer credit are pushing the Brazilian economy into an uncomfortable situation of persistent external imbalances. Unless the government takes serious measures to improve productivity by modernizing its infrastructure, the economy will find itself in an unsustainable trajectory.
It’s not that Brasilia is not doing anything. The interminable traffic jams in some of the major urban centers, such as Sao Paulo, are living proof that the government is in the midst of major construction projects to improve transportation facilities. The new fleet of buses that grace the streets of Rio are a noticeable departure from the smog-spewing monsters that used to plod along. However, President Dilma’s Rousseff’s recent announcement of an R$50 billion reduction in government outlays is creating fears that she is going to try to cut out some of the muscle without touching the fat. She recently took the nation by surprise by announcing a 45 percent increase in outlays for Bolsa Familia. The Brazilian welfare program is designed to support the poorest segments of the country, as well as the well-organized supporters of the PT. While it is noble to help the poor, Brazil should be taking steps to cool consumption and keep the country from overheating. Furthermore, millions of people already moved into the middle class, thus reducing the pressing need for social assistance. Furthermore, it looks like the R$50 billion fiscal adjustment will involve a lot superficial statistical adjustments, as well as reductions in much needed investments. This means that the Central Bank will need to work overtime to help keep inflation in check. The SELIC could easily rise above 13% this year, which means that the currency will most likely remain where it is or become stronger.
The strong Real, booming credit markets and high level of consumer confidence are making the country a consumption paradise. The streets are teeming with new cars. The only Bentley dealership in Latin America is in Brazil. Fashionable boutiques line the avenues, and tony restaurants have long queues of hungry customers waiting to enter. The currency is also somewhat overvalued, and Brazil is particularly expensive for foreigners held captive in the hotels and restaurants of Jardims and Leblon. A short trip outside the compounds will reveal food, lodging and transportation costs that are more reasonably priced. Still, Brazil cannot afford to allow its currency to appreciate any further. The country’s current account deficit could approach $70 billion in 2011. The massive investment program dictated by Petrobras as well as the preparations for the 2014 World Cup and 2016 Olympics mean that capital imports will continue to arrive, thus keeping pressure on the external accounts. Likewise, the economy is starting to slow. The fourth quarter GDP data already confirmed a sharp slowdown in economic activity and the average forecast for 2011 is in the 3.5 percent to 4.5 percent range. Therefore, further appreciation of the currency will only make matters worse by favoring imports over exports. This is why the country’s economic policymakers should not give in to political temptation by hollowing out the fiscal adjustment. Brazil needs to deeply cut into the bureaucratic fat and frivolous expenses in order to stabilize the economy. Otherwise, this party is going to end with a nasty hangover.
Walter Molano is head of research at BCP Securities.