Brasil Responds To An Economic Slowdown

Brazil Responds to an Economic Slowdown September 8, 2011 | 1708 GMT YASUYOSHI CHIBA/AFP/Getty Images Former Brazilian President Fernando Henrique Cardoso and current President Dilma Rousseff on Aug. 18 in Sao Paulo Summary Brazil has made several economic policy shifts recently to respond to an economic slowdown. The policy changes are meant to stimulate growth and safeguard jobs, but these changes also carry the risk of increasing inflation, which is already fueled by a stronger currency and an influx of foreign investment. In order to maintain its popularity, Brazilian President Dilma Rousseff’s administration must balance the need for economic stimulus with controls over inflation. Analysis Recent economic policy shifts in Brazil indicate that the country is  prioritizing the need for growth over the fear of inflation. These include a proposal to reduce general interest rates, the potential approval of a plan to increase the country’s minimum wage and a robust microcredit program. Brazil is preparing not only for a projected global economic slowdown but also for balancing the needs of its declining manufacturing sector with its booming primary commodity export sector. The change increases the danger of inflation — a particularly contentious issue in Brazil politically — and the Rousseff administration will have to calibrate its approach carefully to maintain political popularity. Factors Affecting Brazil’s Economy In the wake of the global financial crisis that began in 2009,  Brazil experienced a significant boom in both exports and investment. Trade with China is the main driver of Brazil’s export growth. China has become Brazil’s largest export destination, primarily importing raw commodities — soybeans, iron ore and crude oil — and their byproducts. Brazil’s exports to China in the first seven months of 2011 totaled $24.4 billion, or 17 percent of total exports (an increase from the same period last year, during which Brazil’s exports to China totaled $16.7 billion and 15.7 percent of total exports). Brazil’s relatively positive economic outlook and stable political system made it one of the most popular destinations for foreign portfolio and direct investment. Foreign direct investment alone amounted to $48.5 billion in 2010, an increase of more than 480 percent from 2003. The huge influx of foreign capital and large trade surpluses have driven up the value of the real. From mid-May 2010 to late July 2011, the real increased by 18.6 percent against the dollar and currently hovers at $1.65 per real. Though the strengthening of the real has a limited effect on producers of commodities (which are traded in dollars), it has directly and negatively affected the competitiveness of Brazil’s value-added manufacturing sector, particularly in combination with lowered global demand for manufactured goods. Strict government controls on Brazil’s economy have included high interest rates and capital controls, reducing incentives for investment. Furthermore, competition with Chinese products both at home and abroad has hurt Brazilian industry; 57 percent of all exporting companies have reported facing competition with the Chinese, and 67 percent of those have already lost clientele to that competition. Shoe, textile and machinery equipment companies have been hit particularly hard: Some 80 percent of Brazil’s machinery and textile industry lost clients to Chinese competition, and 21 percent of the country’s shoe manufacturing industry stopped exporting due to the competition. On the domestic front, 12.6 percent of Brazilian companies have reported losing business to Chinese competition. The Brazilian manufacturing sector’s troubles remained largely isolated as overall growth rose. Now, however, Brazil is seeing the beginning of a general slowdown that is projected to continue in the near future. A lower-than-predicted job creation index (a registered 140,563 newly created jobs in July, as opposed to 215,393 in June), a plummeting stock market index (currently at around 55,000, down from roughly 71,000 in January) and gross domestic product growth of only 0.8 percent through August indicate a slowdown. These domestic indexes, coupled with the ongoing economic crisis and the fact Brazilian government analysts are predicting a downturn in the global economy, have sparked a fear that Brazil’s cool-down could become a recession. Balancing Growth and Inflation Concerns In order to counter this possibility, the government announced several measures meant to stimulate growth and lending. Among these is a measure offered for the National Congress’ approval to increase the minimum wage by 13.6 percent to a total of 619.21 reais per month in 2012 in a regularly scheduled revision of the wage. The government has also said it wants to reduce the general interest rate to 12 percent from 12.75 percent and increase the number of government investment and social spending programs, including the implementation of one of the largest microcredit programs ever seen in the country for small businesses. These policies could increase Brazil’s inflation rate, which is already stimulated by foreign capital and the booming commodities sector; inflation is currently just more than 4 percent for the accumulated yearly index. Brazil is no stranger to inflation: Structural constraints on Brazil’s economy and occasional economic mismanagement have caused inflation rates to fluctuate throughout the country’s history, pushing it to quadruple digits in the late 1980s and early 1990s, which in turn to daily price increases. After a handful of currency exchanges and other measures repeatedly failed to resolve the issue, the Real Plan implemented in 1994 by then-Finance Minister (and later President) Fernando Henrique Cardoso finally ended the period of hyperinflation and stabilized the economy. Since then, inflation has remained an exceptionally dangerous subject in Brazilian politics and economic policy. Because of this, a rise in inflation much beyond the current target of just under 7 percent would be problematic for Rousseff in two ways. First, it would seriously undermine her personal political credibility, since she ran for office on the promise of keeping inflation under control. Second, and more important, any sharp rise in inflation would affect the lower class — the power base of Rousseff’s Labor Party — more than another segment of society. It would also hurt Brazil’s burgeoning middle class (although the measures to increase minimum wage and microcredit can be seen as a way to offset the financial difficulties these groups could face). Though inflation seems highly unlikely to reach the heights of the late 1980s, even an increase to double-digit inflation will be a political problem for the administration and could inspire more incidents like the Sept. 1 student demonstration against increased bus fares in the city of Piaui — that demonstration ended with a bus being lit on fire. It is vitally important, for political and economic reasons, that Brazil’s inflation be curtailed as much as possible, as the government had been doing until recently (for instance, by cutting the federal budget by $36 billion), lest the memory of hyperinflation undermine the government. However, it is equally important that the Rousseff administration protect its own popularity by safeguarding jobs, which requires stimulus- and inflation-inducing policies. With its current policies, the government is indicating that it is choosing growth over inflation control, but the balance it must maintain between the two is very delicate. Give us your thoughts on this report For Publication Not For Publication Read comments on other reports Reader Comments