The economic boom that has buttressed outgoing presidents
Lula da Silvas popularity now comes at a cost: inflation,
currency appreciation and a widening current account deficit.
From day one, president-elect Dilma Rousseff will face an
uphill battle, as she juggles economic realities with
Below follows an in-depth feature on Brazils
macro-economic challenges, published before the outcome of the
October presidential election.
Henrique Meirelles, the longest serving central bank president
in Brazilian history, reckons the Brazilian economy looks
Certainly some of the numbers look good. Economic growth of
around 7% this year is not to be sniffed at. Brazils
finance minister Guido Mantega is already talking about
laying the ground for a welfare state.
Brazils policy-makers are confident their country is
now ready to join the Premier League and little can
derail their optimism over growth.
Yet, not all is rosy. Following five years of surplus since
2003, the current account gap has been widening and is fast
approaching 3% of GDP (up from 1.5% of GDP last year).
Moreover, foreign direct investment, which reached record
levels in 2008 at $45 billion, has declined and will not be
able to finance the deficit any longer.
Ricardo Hausmann, director of the Center for International
Development and a professor at Harvard University, suspects
Brazilian policy-makers of complacency in the face of more
difficult economic data, including a rising current account
I dont have a problem with the current account
worsening per se, he tells Emerging Markets.
But it is indicative that the current rate of economic
growth is higher than the rate of growth that you could sustain
in the long run.
You should not plan as if this was the level of the
long-term rate of growth...elections are excellent times to
create artificial booms.
Marcelo Carvalho, chief economist at BNP Paribas in Sao
Paulo, says: Brazil will have to rely more on portfolio
investment and short-term capital flows, which can prove to be
Most economists forecast that the deficit will worsen in
coming years. This is not yet dangerous, but these things
arent an issue until they become an issue. The trend is
certainly something to watch, says Carvalho.
Finance minister Guido Mantega reckons that this trend is
not a lasting one and will be reversed. We will continue
to register a current account deficit over the next two years,
but there will be a global recovery from 2012, and Brazil will
then be able to increase its exports, he says.
We are prepared for any kind of scenario, even a
double-dip recession, despite the fact that it is not the most
likely scenario, Meirelles tells Emerging
He also rejects any suggestion of renewed vulnerability
out of hand: It is not a vulnerability... No, it
is not a dependency [on short-term capital flows]. If for some
reason at some point, the market thinks the level of deficit is
not sustainable, there will be an adjustment in the foreign
The most important role of the free-floating exchange
rate regime is to balance the external accounts in the long
Meirelles believes the combination of strong reserves and a
free-floating exchange rate will ensure such a readjustment
would not be chaotic. We have sufficient reserves to make
sure that any adjustment is done in time, orderly, without a
reason for any kind of crisis as in 2008, for example, he
FOREIGN EXCHANGE FEARS
In the height of the global financial crisis, the Brazilian
real sank on the foreign exchange market at the end of 2008,
during what Meirelles called the most important foreign
exchange crisis since 1929, but later bounced back (the
government even introduced a tax on foreign investment to stem
the currency appreciation at the end of 2009).
The greatest pressure on the current account comes
from profits and remittances $32 billion. This is due to
the difficult situation of foreign companies to correct their
balance sheets. They are also taking advantage of a favourable
exchange rate, which will not remain as favourable, says
Mantega. There will naturally be some exchange rate
depreciation in the future because interest rates will continue
to fall, and there will be less space for carry trade. This is
an issue that the next government will have to take great care
The view is shared to some degree by the central bank.
Are we worried about a foreign exchange crisis as we had
in the past? says Meirelles. The answer is no.
There used to be two reasons for foreign exchange crises over
the past decades: one is a controlled, managed foreign exchange
rate. When market conditions change, when central banks spend
reserves to defend a specific exchange rate, as happened in
many countries throughout history, at some point you may have a
The other reason is low reserves, even when a country
has a free-floating foreign exchange market. Why? If for some
reason risk aversion goes up, there is a run for exit [flight
to safety]. If you do not have enough reserves, you might have
a liquidity squeeze.
Both problems happened in the past. Today we have a
free-floating exchange rate regime... and we have a comfortable
level of international reserves, which enabled, for instance,
Brazil to face successfully the most important foreign exchange
crisis since 1929, which was the crisis in the last quarter of
2008, says Meirelles.
Brazil was able to act as a lender of last resort in dollars
to the Brazilian banking system, to exporters and other
corporations because we had sufficient level of
WORLD VIEW NEEDED
The big economic issues were largely ignored during the
recent electoral campaign an irony given the two prime
candidates in the presidential race are trained economists.
Lulas protege, Dilma Rousseff, has sought to minimize
the risks of a growing current account deficit. She insists the
increase in imports of capital goods and machinery will
eventually benefit productivity.
José Serra, the opposition presidential candidate,
would have none of this. Its obvious that this is
not the case, says Serra, who has warned against the risk
of de-industrialization and the increasing dependence on
volatile commodity export prices. We are importing
consumer goods. In some parts of the economy this is
already apparent Brazil, for example, is importing fewer
cars than it exports. And the trade surplus has been narrowing
rapidly in recent years.
Serra, who has long opposed the notion of central bank
independence, has questioned the consensual economic policy
tripod (a mix of primary fiscal surplus, inflation
targets and free-floating exchange rate), which has been in
vogue in Brazil in recent years.
Moreover, he has lashed out at what he calls the
perverse tripod, saying we have the highest
tax burden among developing countries, the highest real
interest rates, and the lowest rate of public-sector investment
in the world.
Local economists, such as BNP Paribas Carvalho, point
out that Brazil still needs structural changes, such as social
security reform, to boost the low level of domestic
Nilson Teixeira, Credit Suisses chief economist in Sao
Paulo, also emphasizes the importance of a boost in domestic
If these dynamics [an increase in domestic savings and
the investment rate] are not confirmed, the risk of
Brazils external accounts not being sustainable would
increase. In this negative scenario, the costs of financing the
deficit would increase, leading to stronger economic slowdown
and greater local currency depreciation, the report
Nevertheless, Teixeira rules out any major risk. We
believe that an increase in the current account deficit in
Brazil to levels near 5.5% of GDP in 2015, in a scenario of
moderate global growth and low risk of fiscal insolvency, would
not trigger an interruption in the cycle of strong economic
growth in the country, he said.
The risks of a reversal of economic growth in
connection with a balance of payments crisis are low. This view
is due to the high level of international reserves and the
important changes in the composition of the current account
balance and external liabilities in recent years. (These
include a reduction in external debt and an increase in
liabilities denominated in domestic currency, such as
fixed-income securities in the domestic market.)
When Lula took office in 2003, the economic situation was so
fragile that he had little margin to manoeuvre and no choice
but to stick to the orthodox policies implemented by his
predecessor. Mohamed el Erian, the global fixed-income
investor, recently mentioned that a Wall Street bank actually
recommended him to sell the Brazilian bonds Pimco has bought in
the midst of the confidence crisis.
Now that Lula is about to bow out in style, most political
observers say Brazils economic record looks so strong
that his successor may have little option but to keep to the
There is little room to change, says Meirelles.
Today the working class knows very well the value of low
inflation, and the way there has been an increase in purchasing
power for the average worker in recent years. There is strong
political support for this economic model.
Nevertheless, things could go wrong when the new government
is sworn in at the beginning of next year. That
probability is low, says Meirelles. Thats
because of the number of Brazilians who took advantage of these
economic achievements 31 million Brazilians became part
of the middle class and 19 million crossed the poverty line.
Formal jobs have been created at record levels: 1.5 million new
jobs during recent years, maybe 2 million this year.
All of that gives political support to these economic
policies, he says.