Brazil’s fiscal adjustment under way
Just weeks after the start of Dilma Rousseff’s second mandate, Brazil’s new economic team has already provided signs of commitment to carrying on the much needed fiscal adjustment in 2015.
Brazil’s new Finance Minister, Joaquim Levy, has recently unveiled a market-pleasing package of adjustments. Among the announced measures are increases in taxes over fuels, credit and imports. The package came shortly after cuts in social benefits and increases in bus fares announced in December. In total, the measures implemented so far are due to save up to US$7.6 billion.
If this continues, monetary tightening in Brazil appears to be going at a faster pace than expected. Although the new measures still need approval by the Congress to be become permanent, Ms Rousseff seems truly willing to rein in government spending. Even in the face popular criticism, the leftist leader did not hesitate to veto an income tax break approved by the Congress in the past week, saving Brazil another US$2.7 billion.
The question that remains therefore is not so much whether the government is willing to reform, but how much this will cost the country in terms of growth in 2015.
On the edge of recession
In an interview at the World Economic Forum, in Davos, Mr Levy restated his intentions of implementing monetary discipline and acknowledged that negative growth is expected in the first trimester. The Minister however declared that the temporary contraction would pave the way for solid growth in the future.
Although Mr Levy’s cautious forecast already contrasts with those of the ever-optimistic former Minister, Guido Mantega, skepticism remains over whether Brazil can recover from a severe fiscal crisis and institutional turmoil in three-months time.
First of all, the market has only now been able to gauge the dimension of Brazil’s deficit as the Central Bank announced the official numbers on 19 January. Brazil’s total fiscal gap in 2014 reached US$91 bi and was therefore wider than expected. The negative balance, which is the highest ever registered by Brazil’s Central Bank, was mainly due to a trade deficit in the current account, as well as reduced inflow of FDI.
Moreover, Brazil’s Central Bank increased the benchmark interest rate (SELIC) by another 50 basis points, from 11.75 to 12.25 per cent, on 21 January, as inflation rose above the 6.5 per cent target. According to the national statistics office (IBGE) inflation over the 12-month period since January 2014 reached 6.69 per cent, the highest level in the past three years.
It remains to be seen how drastic an impact the adjustment will have over the industry. The slowdown in consumption and the higher costs of credit have already altered investment planning for Brazilian companies. Recent research by the Brazilian National Confederation of Industry has shown that the manufacturing sector is to significantly reduce investment in 2015, with less than seventy per cent of companies planning new spending for this year.
Apart from sky-high interest rates and increased taxation over credit, other paralyzing factors seem to be getting in the way of recovery for Latin America’s largest economy this year – namely, Brazil’s current energy crisis.
The recent droughts that have afflicted the South, Southeast and Center-West regions of the country have reduced hydroelectric power generation to concerning levels. Insufficient production forced Brazil to import energy from Argentina after ten Brazilian states experienced a blackout in the past week.
Moreover, as the drought does not seem to subside, the alternative has been the use of natural gas, a more expensive source of energy. As a result, Brazilians are expected to face a thirty per cent increase in electricity bills this year, which is also due to impact the industry.
Furthermore, not only domestic hazards are to frustrate expectations in 2015. Brazil will also have to cope with a year of low commodity prices and slower growth in China. High commodity prices and the Chinese growth have been important propellers for Brazil’s growth in the past and were largely responsible for trade surpluses.
Finally, the difficulty of regaining investors’ confidence in a stagnant economy is further aggravated by the recovery of the US dollar, against which the Brazilian real has been continuously depreciating. To support the currency and to lower import prices, Brazil’s Central Bank sold over US$98 million in currency swaps on Friday (23 January).
The recently announced bond-buying program by the European Central Bank, however, is likely to play in Brazil’s favor. The higher costs of borrowing in Brazil associated to the stimulus program implemented in the Eurozone should help boosting investment as the Brazilian real becomes more attractive to investors.
A future recovery
Though the fiscal adjustment, if successful, will improve macro-conditions in Brazil, it is now clear that recovering growth and avoiding a second consecutive year of trade deficit will involve tackling challenges that have long haunted Brazilian leaders.
For starters, Brazil needs to search for ways of integrating global supply chains, from which it remains relatively isolated. Exporting seems to become ever more challenging for the Brazilian industry while the country’s trade balance remains largely dependent on commodity prices. Moreover, the current energy crisis has put in evidence bottlenecks in infrastructure and insufficient planning that lower investment confidence.
However gloomy the prospects for Brazil might be in 2015, the transformative impetus that appears to have emerged is positive as it welcomes the possibility of change in a country trapped with slow growth and high inflation for over three years. Attention however should be paid to old challenges and external hazards that are now eclipsed by the fiscal and institutional crises. They will help determine how Brazil will fare in its recovery – whether it will face a temporary contraction or be plunged into recession.