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Brazil’s 5 Big Challenges

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Brazil entered technical recession in the second quarter of this year but with Aécio Neves, seen as the more business-friendly of the candidates, coming an unexpected second in the first round of Brazil’s presidential election; hopes are high that the country can regain its mojo if he builds on his success into the second round. Yet whoever wins, Brazil’s challenges should not be underestimated – a programme of structural reform is necessary to turn the economy around.

1. Shifting from consumer driven growth

Brazil’s recent economic growth has been driven by a consumption boom. Consumer expenditure increased by 28.7% between 2008 and 2013 in real terms – twice the increase in overall economic growth, driven in large part by a corresponding increase in credit. With high inflation and a tighter monetary policy, consumers are feeling increasingly squeezed. This model of growth is not sustainable in the long term; rather the economy needs to see an increase in investment. Gross fixed capital formation, a measure of investment, was just 18.2% of GDP in 2013 – very low compared to other major emerging markets including China, India, Mexico and Turkey.

Gross Fixed Capital Formation as a % of GDP in Selected Emerging Markets: 2013

Source: Euromonitor International from national statistics/Eurostat/OECD/UN/IMF

2. Deficient infrastructure

Brazil’s infrastructure challenges are not news, but are nevertheless a serious impediment to economic growth, with infrastructure bottlenecks adding costs to business. Some improvements were made in the run up to the World Cup, notably to airport capacity, but urban transport is weak, leading to long commuting times. It also remains costly and time-consuming to transport freight by road or rail – incredible for a country which relies on commodity exports. The World Economic Forum’s Global Competitiveness Report 2013-2014 finds that the inadequate supply of infrastructure is the most often cited impediment to doing business in the country. The same report ranks Brazil at 114th out of 148 countries in terms of quality of overall infrastructure, with a particularly poor performance in the quality of port infrastructure, where Brazil is placed 131st. Increasing public and private investment in infrastructure is crucial to secure long term growth. Infrastructure has been identified as a policy priority by the present government but the impact so far has been lacklustre.

The Most Problematic Factors for Doing Business in Brazil

Source: World Economic Forum Global Competitiveness Report 2013-2014

Note: Respondents were asked to select the five most problematic for doing business in their country and to rank them between 1 (most problematic) and 5. The bars in the figure show the responses weighted according to their rankings.

3. Rolling back the government

The government extends its reach into many industrial and commercial sectors undermining the development of the private sector. The government is also involved in price intervention. For instance it has obligated the state oil company Petrobras to sell imported oil below cost price in an attempt to contain inflation. Price controls deter business from investing as it is not clear if the return on investment will be worthwhile. Of course removing price restrictions will in the short-term push up inflation – another of Brazil’s bêtes noires - and it also risks re-stoking social protest seen in the run-up to the World Cup. The challenge within the challenge will therefore be to lift price controls in a considered approach which impacts on inflation in the least damaging manner.

Inflation in Brazil: January 2008-August 2014

Source: Euromonitor International from national statistics/OECD/IMF

Note: Data refer to changes over the same period of the previous year, non-seasonally adjusted.

4. Mounting fiscal pressures

Linked to the level of government interventionism, is a deteriorating fiscal position. Government spending has increased sharply since 2008 and accounted for 40.4% of GDP in 2013 – compared to 25.9% in Mexico. Much of this expenditure is directed at social benefits, rather than investment, which on the one hand has helped lift vast numbers out of poverty, but on the other hand means that government spending contributes to the consumption boom but not to long-term economic growth. The budget deficit was 3.3% in 2013, above the average for emerging and developing economies. This deficit also has to be seen in the context of Brazil’s reputation for high taxes – cited in the World Economic Forum Global Competitiveness Report as the third most problematic factor for doing business. Despite high tax rates, the Brazilian government is still spending beyond its means. The deficit limits the government’s room for policy manoeuvre - a particular problem during a period of slow economic growth and high inflation. Added to these ills, Standard & Poor’s (a ratings agency) downgraded the country’s credit rating in March 2014, because of rising public debt and the government missing its fiscal targets.

Government Expenditure as a % of GDP in Brazil and BRIC: 2008-2013

Source: Euromonitor International from International Monetary Fund (IMF), Government Finance Statistics (GFS)/national statistics

5. Erosion of competitiveness

Brazil is also suffering from declining competitiveness as a result of rising costs and wages. The minimum wage for instance has increased by 61.3% in real terms since 2008 – compared to 1.0% in Mexico. At the other end of the spectrum, skills shortages are also a problem - in 2013, only 9.5% of the Brazilian population aged 15 and above had a higher education degree. At the same time as rising wages, productivity growth has been sluggish, increasing by 2.9% in US$ terms between 2008 and 2013. These factors are all exerting downward pressure on exports. Ensuring Brazil is fit to compete globally is an important challenge for the government because lower commodity prices have increased the need for the economy to diversify and increase exports of manufactured goods. However, because of a lack of competitiveness exports actually contracted by a small amount in 2013 – 0.2% in US$ terms.

Growth in the Minimum Wage in Selected Latin American Economies: 2008-2013

Source: Euromonitor International from International Labour Organisation (ILO)/national statistics

A potential giant

These challenges paint a depressing picture of a large, emerging economy unable to live up to its potential. Although the economy has transformed since its days of hyperinflation and has many strengths: including its sheer scale – in 2013 Brazil was the world’s 7th largest economy (in PPP terms), had its 6th largest population and spans its 5th largest land area - it is also home to a vast array of natural resources. Yet without far-reaching reform, the economy is in danger of returning to the bad old days with its potential remaining - just that - potential.

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