- Impact of global fall in commodity prices on Brazil
- Macroeconomics surrounding the recession in Brazil
Brazil, which is one of the major emerging economies and is a part of the BRICS (Brazil, Russia, India, China and South Africa) group has not been in best of its shape over the past few years. The broader economy recuperated positively from the global financial and economic crisis during the 2008-12 period and once again moved back into the negative territory. This time majorly weighed down by the internal factors as equated to the externals. The economy moved into recession during Jun. 2015, after recording two continuous quarters of GDP decline at 1.3% and 1.9%, respectively, in March and June 2015 (QoQ comparison), while it continued into a recessionary phase until 2016 before eking out to a moderate growth in 2017.
Moreover, prior to the period of the recession, the demand for commodities (as Brazil is a resource rich country) from key economies around the globe and particularly from China; aided to a decent support of the economy. Brazil runs a positive trade balance backed by healthy exports of minerals, metals, energy and agricultural commodities along with other manufacturing components globally. The nation was furnished with very strong capital inflows in terms of the FDI, equity investments, bond issuances among others and largely supported the optimism in the economy. The Brazilian real appreciated during this period and many Brazilian companies including the state-owned Petrobras took advantage of the situation and borrowed from international markets, in order to fund their long-term CAPEX. The growth was also driven by a policy support from the central bank, which reduced the benchmark interest rates, while tax exemptions were given by the government.
Notwithstanding a positive trade surplus and capital inflows, things were beginning to weaken internally, as major industries were hit by an appreciation in the local currency as it strained the export competitiveness. This alongside the tax incentives and other populist measures by the government inflicted the fiscal situation of the economy. The situation went out of the way when major commodity prices started declining internationally, especially around 2014. Further, Brazil is highly dependent on commodity exports with primary products being iron ore, crude oil and soybean. Furthermore, currency movement was witnessing a reversal, which added to the woes. While, this aided a moderate benefit to exporters; but it dragged the performance of companies and equities while it also affected fresh capital inflows. The corporates which took foreign borrowings were the most impacted as they faced the double whammy of falling commodity prices along with increasing financial costs due to the currency depreciation.
Among all the major contributors to the economic downfall were the losses incurred by the state-owned companies and particularly Petrobras. The company holds an essential space in the Brazilian economy as it produces more than 90% of the petroleum products. It owns all the refineries in Brazil, it leads in gas and diesel distribution and also operates a large number of service stations. Petrobras alone accounts for over ~10% of the Brazilian GDP.
Addedly, as the government revenues contracted amid a falling economic output, the fiscal prudence was the need of the hour with a restraint on freebies, in terms of various social subsidies, the big bang pension spending and other socialist expenditures should have been cut to avert a further downside. The inflation was rising, while industrial production, capacity utilisation and retail sales moved to their worst levels in at least a decade. The central bank tried to tame inflation by raising the interest rates, which moved up from 7.25% to 14.25% during the middle of 2015, though, it circuitously pressured the industry performance and also pinched the consumer with increasing loan repayments.
The negative effects were visible on the labour front with unemployment rate moving into double digits after averaging ~6.8% in 2014. The domestic currency depreciated by ~80% between Aug. 2014 to Jul. 2015 and hanged at a ~4 mark (USD/BRL). The fiscal balance deteriorated making things tougher for the government as a whole. It was required to assess the entire situation from a macro perspective, taking measures to cut down expenditure as well as provide fiscal and monetary support.
Nevertheless, the road less travelled was avoided by the then President Dilma Rousseff, wherein the economy was supported by another round of stimulus without taking a proactive action on spending. While the government did try to put a cock on the spending much deeper in 2015, the economy has already moved in trouble by then and started contracting sharply. Brazil moved into its worst recession in the history with its GDP descending from US$ 2.42 trillion (2014) to US$ 2.34 trillion (2015) and further lowering to US$ 2.26 trillion (2016), recording a negative growth of 3.55% (2015) and 3.47% (2016), respectively.
The ill effects from the changing dynamics on the business and economy front were conjugated with political and corporate issues related to corruption. It was Petrobras that fuelled negativity and tilted the system downwards; on one side financials of the company deteriorated, separately the company was marred with a slew of corruption scandals involving top officials. This spelt doom for the already ailing economy, the government and the Petrobras officials were found guilty of corruption for awarding construction and service contracts at high-costs to suppliers. Further, scores of politicians, including the two former Presidents Lula da Silva (the founding member of the then ruling Workers' Party under President Dilma Rousseff) and Fernando Affonso Collor along with a number of corporate executives were prosecuted under the so-called ‘Operation Car Wash’ in Brazil (2015 and 2016). They were charged for swiping away billions of dollars from the system.
Amid the ongoing economic doldrums, separate allegations regarding manipulation of the government accounts costed Dilma Rousseff her presidency, who was impeached on the 17th of Apr. 2016, following which the then Vice President, Michel Temer (the coalition partner and the member of the Brazilian Democratic Movement Party) became the acting president. The new government under Mr Temer took a critical approach, in terms of taming down the expenditure, especially the ones related to socialist segment, though the same was met with heavy opposition from the public. Even before the start of the second presidential term for Dilma Rousseff (2014), Temer was highly vocal about taking a path which involves critical reform measures for the economy and moving against the ultra-pro-public policies as formulated by Lula da Silva (Presidency term 2003-12) and later also followed by Dilma Rousseff usually named as the ‘Lula Model’. Hence, with the change in the helm of affairs, Temer pushed for austerity measures to get back the fiscal situation on track, while also managed to infuse a gradual, but smoother upward movement in the economy. In December 2016, the Brazilian government approved abrasive economic reforms to cap the social spending by the government for two decades. The PEC 55 as the legislation being known, would freeze public spending on education, healthcare and social assistance for 20 years, while allowing it to rise only in-line with the inflation rate.
While this move was criticised by the public, opposition, and political parties and the UN, these amendments backed by legislation were largely taken up positively by foreign investors, businesses, economists as well as international rating agencies, which considered these as steps wherein government is trying to curb excessive spending as against the case with the previous four terms. The earlier governments under Lula da Silva and Dilma Rousseff saw fiscal situation largely untamed as they followed progressive approach, which was backed by strong physical and social infrastructure with heavy investments in education, healthcare, competitive taxes, subsidies among others as also stated above. The fiscal deficit which averaged 2-3% for the much of 2005-15 period, spiked to ~10% in 2015 and stood around that range for next year as well with commodities moving in the downward trajectory, whereas national debt continued to rise.
Temer’s reform measures aided some support on this aspect and drove a huge rally in Brazils’ equity, currency and bond markets and drew huge support in form of international investors over the past two years. The benchmark equity indices, Bovespa started gaining traction since the start of 2016 on expectations and impeachment of the then president Dilma Rousseff which would have completed soon, while Michel Temer would have tried and retained spending as well as push growth measures. The equity benchmark has more than doubled since hitting a low of nearly ~38,000 mark in Jan. 2016, while following a near one-way move. Bovespa touched a life high above the 87,000 mark on the anticipation of further reforms on labour, privatisation, oil and gas asset sale along with the big bang push to cap the pension bill.
Temer’s economic push was being supported with central bank’s actions over the rate cut, which after the historic high levels of ~15% were reduced to over 800 bps since late Sep. 2016 to record lows of 6.5% in March 2018 and have stayed at the level since then. This has helped corporates and individuals, while most other major economic data have also rationalized during this time. The CPI (consumer price index) moved down to low single digits of around 3% range for most of 2017, while it has inched higher towards 5% levels over the last few months. A contraction in the WPI (wholesale price index) was normalised, while other readings over industrial production, retail sales, currency and leading economic indicators, namely industrial confidence, consumer confidence, vehicle production among others stabilised or saw improvement since their respective weakest points in last 2-3 years. The trade surplus jumped to its record levels, adding positivity to the government revenues, which are yet to see a strong growth. The GDP which marked two consecutive years of contraction has managed to turn positive in 2017, rising by 1% and getting a thumbs up from the government as well as the IMF on the end of the worst recession in Brazil.
Televisory believe, while Brazil has surely stabilised from the dreadful economic situation witnessed during 2015 and 2016, it is still not out of woods yet. The country needs continuous reforms where a balance between growth and austerity has to be maintained.
While Temer and his government have been successful in getting a few aspects cleared on the austerity front, especially the spending cap on the social sector and labour reforms, privatisation is a continuous process, though they seem to be taking steps in the right direction. The pension reforms, which form the core issue related to high government debt was one of the key agendas targeted initially, though shelved during the start of 2018 following a lack of support and consensus among political parties and a huge backlash from the public. Despite Temer’s government focus on work, which has largely been lauded by economists, there is still much which needs to be done. The current government is in place until the end of 2018 with Brazil facing presidential elections in October. This is also one of the important reasons, the current government, coalition partners and other political parties did not push very hard on the pension bill as nobody wanted to face the public ire in the forthcoming elections. It is being left for the future government to decide upon some of the crucial reforms. This means that Brazil’s political scenario to an extent is moving towards a grey area as economy and socialism are moving on completely divergent paths. The general public wants a government which is pro-people and there has been the condemnation of the measures approved by the current government.
The economy has just managed to start again, a new government would be in a fix, though there are high indications towards the formation of a gentler one as predicted by the latest pre-poll surveys in the country. Temer’s political party and the current government are least popular, while Lula da Silva, who is in jail and wish to run for the presidency and is the most favoured candidate. He is out of the picture, though as Brazil’s ‘Clean Record Law’ puts a ban on anyone with a criminal record from seeking a public office. There are already visible concerns on elections for the markets, wherein the Brazilian real has depreciated around 20% since the start of this year, while equity markets too have trimmed to modest gains after touching highs of over 87,000 levels in Feb. 2018. In the worst-case scenario, if the outcome of the results favours a political party, which is largely going to follow some or the other form of the so called ‘Lula model’, there can be a huge negativity seeping in terms of financial markets, which might even lead to exits from local as well as foreign investors. While real aspect can only be seen as per the outcome of the elections, the current election is viewed as one of the most crucial ones as the elected representative would have to deal with a double edged sword of managing public expectations and economic measures. The near-term fate of the country is dependent on how and at what steps does the new leader would move!