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Friday, October 3, 2014

Brasil's Next President Will Have To Focus On The Economy

Brazil's Next President Will Have to Focus on the Economy

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Summary

Brazilians going to the polls to select a new president Oct. 5 will choose between incumbent Dilma Rousseff of the Workers' Party, challenger Marina Silva of the Socialist Party of Brazil and Aecio Neves of the Brazilian Social Democracy Party. Although the candidates differ ideologically, longstanding structural realities that have restrained the country's economic development will significantly influence the next president's policy decisions, especially how to reverse Brazil's economic slowdown.

Analysis

After a long presidential campaign, the Brazilian election has narrowed into a race between Rousseff and Silva, who replaced Eduardo Campos as the Socialist Party's candidate after his death in an Aug. 13 plane crash. Silva surged in the polls in August and was in a virtual tie with Rousseff at one point. Rousseff has retaken the lead in recent weeks, although new polls suggest a second round of voting pitting Rousseff against Silva is likely.
Regardless of which candidate wins the election, the next Brazilian president will have to contend with a set of structural constraints that are slowing the national economy. The incoming government will face the difficult task of spurring economic growth and cutting government spending while maintaining high levels of social spending and relatively low inflation rates, initiatives that have underpinned the ruling Workers' Party's political support for the government in recent years. Brazil will try to accomplish this by implementing short-term measures such as reducing interest rates, cutting government spending and increasing the price of fuel and electricity. The country will also try to expand into foreign markets in the coming years. Despite its inherent limitations that hamper its economic growth, however, Brazil will not abandon the framework of the Common Market of the South, better known as Mercosur.

Brazil's Recent Economic Struggles

The economic slowdown in Brazil is part of a trend that has been steadily worsening for several years, largely caused by falling commodity export levels. The Brazilian central bank predicts the economy will grow by 0.7 percent in 2014, the slowest yearly increase since 2009. Despite falling demand abroad, Brazil will have to continue its reliance on commodity exports as a primary driver for economic growth for now.

After the global financial crisis began, Chinese demand for commodities shielded Brazil from having to rely on its increasingly uncompetitive manufacturing sector as a source of revenue. Indeed, Brazil exported 23.6 percent of its $226 billion in exports for 2013 to China. Of that amount, nearly 83 percent was from commodities, including soybeans, iron ore and oil. This strategy aided Brazil's continuing economic growth immediately after the recession but left it vulnerable to fluctuations in demand.
Since 2011, however, the rate of Chinese imports from Brazil has declined, likely because of slowing demand for certain commodities in China. Exports of soybeans, iron ore and oil to China rose by only $1.5 billion from 2011 to 2013. Brazilian exports during the first eight months of the year have decreased from their 2013 amount by nearly $2 billion and will continue to slow in 2014.

Brazil's weakening manufacturing base will continue to exacerbate the impact of the slowdown in commodity exports. Manufacturing has formed a smaller and smaller part of Brazil's gross domestic product for decades. As of 2012, manufactured goods formed around 13 percent of Brazil's overall GDP, compared with about 17 percent 20 years earlier, and now make up some 36 percent of total exports, down from nearly 50 percent a decade ago. Mercosur trade barriers, direct competition from China and the inherent difficulties created by Brazil's terrain and size hinder any significant growth in Brazilian manufacturing. These factors have all made Brazilian goods expensive to produce and highly uncompetitive at home and abroad.

Transportation is perhaps the constraint on the Brazilian domestic economy that can be addressed most immediately. Just over 50 percent of cargo in Brazil is currently transported via road networks. The country's great distances, limited infrastructure connecting rivers to production centers and difficult terrain have for decades made significant expansion into alternate forms of transportation highly expensive or impractical. The government is trying to address the transportation problems with an infrastructure improvement program aimed at constructing new railways, roadways and airports to alleviate bottlenecks. The federal government will likely auction the program's first railway construction contracts in the coming year and will continue constructing roads already in progress.

Mercosur's Limits on Brazil

None of the barriers that hamper Brazil's economic growth can be removed in the short term. The structural inhibitors of the Mercosur trading bloc will continue to hinder Brazil as it looks for new markets abroad. Argentina, the second-largest economic power in Mercosur, needs the institution's inherent protectionism to defend its own domestic industry, something that hurts Brazilian exports.
At the same time, the bloc's rules limit Brazil's ability to sign potentially lucrative trade agreements abroad. Under the organization's charter, new trade agreements require unanimous Mercosur approval, and resistance from Argentina has already delayed a potential free trade agreement between Brazil and the European Union for several years. Given its worsening economic difficulties, Argentina is unlikely to agree to any potential competition to its domestic industries any time soon.
Argentina's continued intransigence could force the next Brazilian president to seek changes to Mercosur, something that would in turn force Brasilia to significantly alter its political relationship with what has been the dominant South American trade bloc for decades. In coming years, Brazil will likely look for deals in smaller regional markets such as Peru and Venezuela, and it could continue pressuring Argentina to agree to a Mercosur trade deal with the European Union.
Meanwhile, there is little Brazil can do to limit competition from China in its domestic market in the short term. Even with the existing trade barriers, cost-competitive Chinese exports to Brazil rose nearly tenfold to $37.3 billion between 2004 and 2013, steadily displacing Brazilian manufacturers.

Inflation

Limiting inflation to avert social unrest has been a top priority for successive presidents since the early 1990s and will continue to be a priority of the next president. Since the early 90s, the Brazilian government has relied on a macroeconomic strategy colloquially referred to as "the real plan" to develop modest economic growth while limiting inflation.
Although inflation in Brazil has been relatively low for a decade, it will likely approach the central bank's annual limit of 6.5 percent in 2014. Reports indicate that Brazil may try to stimulate its economy by lowering credit restrictions and reducing interest rates. These moves, along with initiatives to boost government revenue, including increases in the price of fuel and electricity, could spur inflation. Allowing inflation to rise too sharply, however, risks increasing political unrest.
Because of slowing government revenue, a cut in public spending is also likely in the coming year. Finance Minister Guido Mantega has said a financial adjustment similar to what was observed in 2011 could be carried out in 2015. Any cuts in government spending will likely attempt to spare most social spending (around 14.4 percent of GDP in 2010), a major source of public support for the Workers' Party but a notable expense for the national government.
The next Brazilian president will continue to deal with the challenges that have defined Brazil for decades but will do so under the burden of increased expectations from Brazilians. The government will have to carry out necessary economic adjustments in the coming years, and the measures could increase the risk of social unrest. Brazil saw widespread demonstrations in June 2013, many of which were spurred on by ongoing grievances such as the rising cost of living and political corruption. With increasingly difficult decisions on the horizon, the next president will probably have to address the difficult task of crafting economic adjustments designed to improve the economy without alienating constituents.


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