Brazil’s Cautionary Tale of Economic Woe and Recovery

If Brazil has ever suffered from a financial turmoil, it mostly has been more of a contagion effect like the 1997 Asian Crisis and 1998 Russian Crisis.  It has been considered one of the strongest emerging markets and a large contributor towards global growth. However, things started looking a bit foggy for Brazil since 2008 financial crisis. It was observed that a country that could be a potential contributor to global growth could also pose an equal threat to financial stability.

If Brazil has ever suffered from a financial turmoil, it mostly has been more of a contagion effect like the 1997 Asian Crisis and 1998 Russian Crisis.  It has been considered one of the strongest emerging markets and a large contributor towards global growth. However, things started looking a bit foggy for Brazil since 2008 financial crisis. It was observed that a country that could be a potential contributor to global growth could also pose an equal threat to financial stability.  But before we reach any conclusion for 2014, it is important to look back as to how Brazil evolved as a country and stood strong even when everything around her was collapsing.

The Story So Far…

Brazil went through industrialization process from 1950s to 1970s. This led to expansion of some very important sectors like automobile, petrochemical and steel. In early 1980s, an increase in interest rates across the world forced Brazil to implement strict economic adjustments that eventually led to negative growth rates. 

Capital inflows were suspended making it difficult for Brazil to invest. Public finances were affected and this resulted in inflation. Brazil was quick enough to take stringent actions in second half of 1980s. It aimed at monetary stabilization, which included the end of indexation and freezing of all prices. Indexation is a policy of adjusting wages and contracts according to inflation. Even though history witnesses that such measures were never a big hit, Brazil’s economy still grew and provided enough surpluses in trade balances that covered its debt.

The 1980s crisis raised doubts about Brazil’s import substitution model (a policy that emphasized on self-sufficiency-producing domestically rather than purchasing from abroad) and this helped Brazil to open doors for trade liberalization, privatization and establishment of legal and structural framework to promote foreign investment. 

The Real Plan

Brazil wanted to take steps in 1994 that would bring down inflation. Brazilian government tried to introduce the Real Plan. The Real Plan was a stabilization plan that would replace the currency then in use by the Real. The plan was successful and manages to achieve reduction in prices. This ended the three-year inflation that Brazil suffered from.  The end of inflation brought a lot of good news for Brazil some of which were:

• Improvement in income distribution

• Restoring the currency value

• Increased economic growth

• Increased purchasing power of lower layer of population

• Significant reduction in poverty

Brazil joined WTO in 1995 and as member reformed its economy that were in sync with the WTO regulations. These measures included abolition of state monopolies, reduction or elimination of trade barriers in goods and services as well as subsidies. 

1997-1999 was a period of occurrence of series of financial crisis. Russian Crisis led to significant losses of reserves for Brazil and other emerging markets.  Aftermath of 1998 Russian crisis ended the floating of the Real in 1999.  Russian Crisis led to many events and raised question like: If there was lack of Capital trade and direct financial linkages then why did Russian devaluation affect Brazil’s capital situation? However, answering these would be a different paper altogether. The timing of the Asian Crisis that occurred before Russian Crisis made Brazilian economy prone to the devaluation of exchange rate. But the impact of Asian and Russian Crisis on Brazil were a bit different. Official withdrawals were huge in number during the Russian Crisis when compared to the Asian Crisis. These withdrawals were mostly by foreign investors that remained in panic due to the Russian Crisis. However, Brazil made a successful transition to floating exchange regime. The stringent fiscal adjustment program ensured long-term stability of fiscal account. There were rigorous laws that established limits of personnel expenditures at all levels – federal, state and municipal.  Despite the economic crisis in 1999, Brazil followed its trade liberalization path.  Brazil had stood strong for its macroeconomic policies and substantial structural reforms.  In 2000, Brazil received its first surplus with exports growing steadily especially in aircraft and telecommunications sector.

Brazilian economy has been dynamic and diversified and its prompt response to various crises can be a leading example to many economies.  Brazil’s policies that ended long lasting monopolies and established strong privatization of steel, telecommunications and electricity sectors have been a key in increasing volume of FDI inflows.

The 21st Century in Brazil

The 21st century saw Brazil’s economy moving to the one of the largest economy by nominal GDP. It became one of the fastest growing economies and is expected to be in the top five largest economies of the world. The 1990s reforms towards fiscal sustainability, more economic freedom and better environment for private sectors made it possible for Brazil to be the largest Latin American nation. Since 2003, many Brazilians joined the middle class and were lifted from poverty. With the formation of BRICS (an association of major emerging economies: Brazil, Russia, India, China and South Africa), it became evident that Brazil wanted its economy to depend less and less on its economic ties with America. But the growing debt of Brazil raised some issues with the arrival of 2008 financial crisis. Even though Brazil witnessed high growth rates, it was a bit too early to say if it had sailed through the crisis. It was concluded that 2008 had hit Brazilian economy despite of contradiction that it had strong macroeconomic fundamentals. But the twist in the story here was that although the economy was deeply affected, it did not last too long. 2009 soon saw Brazil’s recovery. The strong banking system of Brazil played a vital role in it and this was further possible with the efficient layout of the Real Plan that helped the avoidance of systemic crisis.

2010 saw Brazils’ best economic performance in 25 years. By 2012, it replaced UK and became the world’s sixth largest economy. However, 2013 unveiled a different picture of Brazil. Brazil recorded a government debt to GDP of 56.80% of the country’s Gross Domestic Product in 2013. Increased public transportation fares in Brazil heightened grievances related to the slowing economic growth, corrupt political system and constant government intervention. Regulatory efficiency remains poor, and the application of regulations is inconsistent and non-transparent. This unimpressive picture of Brazil made many economists question about the economic freedom that was the basic fundamental right of every human to control his or her own labor and property. Nationwide protests highlighted the corrupt system of Brazil and how the judiciary was inefficient and subjected to political and economic influence. Credit markets were slowly expanding and banking and capital markets are steadily getting more and more diversified. Brazilians are still not allowed to import used clothing or cars and the government limits foreign investment in many sectors.  

In 2014, Brazil started to feel the aftershocks again with the first half-year brought technical recession in Brazil but in the third quarter, the Latin America’s biggest economy slowly got out of recession.  “The economy at least escaped the recession, but the stagnation is very deep,” said Newton Rosa, chief economist at São Paulo-based asset management firm Sulamerica Investimentos. “We are in a low-growth trap.”

Unlike 2008, though, economists say the problems facing Brazilian consumers now are mostly domestic. Families that borrowed to help finance a recent consumption boom are now struggling to pay down their debt in an environment of sticky inflation and some of the world’s highest interest rates. To many economists, the problem in Brazil has just started and it should focus on efforts to bring down its debt. Credit-ratings firms have said early this year that Brazil could lose its coveted investment grade if government accounts don’t improve.

But the good news to many is that Brazil has been there and done that and even if the escape in 2014 was a narrow one, it won’t be surprising to see Latin America’s largest economy returning back to its good old glorious days in 2015…however corruption led by strong political influence on the judicial system still remains an unnoticed issue!

Brazil – A Narrow Escape from Recession is republished with permission from The Financial Keyhole