“The signs for Brazil are encouraging. Indeed, the country may have crossed that threshold from volatile to at least the beginnings of durable growth.” These words were written in the OECD Observer in 2001, and how close to the mark they proved to be. In fact, after weathering a shaky couple of years internationally, Brazil’s economy rose to new heights, establishing itself as one of the world’s most lucrative emerging markets.
Its GDP has grown by some 4.6% per year on average over the last five years. A glance at the macroeconomic indicators over that period shows buoyant activity in agriculture, industry and services, while the GDP has been driven by strong expansion in domestic demand and imports of goods and services have risen sharply. Export volumes have also grown strongly, but at a slower rate than imports. Unemployment has been relatively low at around 6-7%, and fell below 5% in December 2012.
Brazil briefly felt the chill of the economic crisis that spread from the OECD area, but quickly recovered. In fact, in 2010 the economy registered its highest annual growth in 20 years. However, this slipped back in 2011, with growth of just 3%. This is still above what is observed in OECD countries, but is the lowest rate in South America that year. The government is determined to haul growth back to over 4% in 2012, though this ambitious target entails some major risks. The OECD more cautiously sees reaching that figure as a possibility for 2013.
The challenges are formidable, particularly given the rather bleak global economic outlook. Even putting the external front aside, the dilemmas are several. For instance, despite higher prices, can the government keep the lid on the policy interest rates and avoid attracting too much short-term capital or exerting upward pressure on the Brazilian real? Or can policy makers achieve lower interest rates for domestic borrowers, but at the same time raise savings rates for investment and keep inflation at bay?
From 2003 to 2010, the appreciation of the real, fuelled in part by short-term capital inflows and a demanding oil industry, amounted to 63% compared with its main trading partners and by 74% against the US dollar. Inflation pressures have emerged. Prices rose by an end-of-year of 6.5% in 2011—the ceiling of the monetary policy target range and the highest rate in seven years. A surge in food and energy prices has not helped, while housing and transport prices have also risen. To prevent excessive currency fluctuations and safeguard financial stability, the authorities initially combined increases in interest rates and reserve requirements with foreign exchange intervention and a temporary tax on short-term capital inflows. As the global outlook worsened, the policy mix was shifted towards easier monetary policy and some fiscal consolidation. If this proves insufficient, policy makers could resort to raising the tax on short-term capital inflows, adjusting capital requirements for banks, and other macro-prudential measures of this sort. Still, they should give more prominence to fiscal consolidation too.
Brazil’s macroeconomic policy has been sound since it was established a decade ago, with the Fiscal Responsibility Law in 2000 being a notable factor. The government has kept a sharp eye on inflation, maintained a flexible exchange rate and stuck to a fiscal policy with clear rules. The authorities have easily achieved their primary surplus target for 2011. But a confluence of slowing domestic growth and a more turbulent external situation has made it hard to keep pressures at bay, with the exchange rate rising and fiscal rules harder to implement.
To deal with these issues and underpin public and social security finances over the medium term, the government could move to a headline budget target and introduce an expenditure ceiling. Ending the link between the minimum pension and the rapidly rising minimum wage (while maintaining the value of the pension in real terms) would also contribute to spending restraint. In addition, making the budget process less rigid would help by making it easier to re-allocate funds to more effective uses.
At the same time, however, the government knows there is a need for more spending on infrastructure, not just in the headline area of sport—Brazil will host the 2014 FIFA World Cup and the 2016 Olympic Games— but in transport, electricity, and water and sanitation that the country urgently needs for progress and medium-term growth (see article: “Infrastructure: Not just a sporting challenge”). Again, this underlines the need for measures to boost investment.
It also means having to make good use of revenues from the oil sector and sharing them equitably, not just across regions, but across present and future generations as well. The new Fundo Social do Pré-Sal (social fund) is encouraging in this regard.
Undoing Brazil’s Gordian knot of taxation would be a major boon to these efforts, as complex taxation has the effect of reducing after-tax returns and curbing incentives to invest. Can the government disentangle it? It certainly plans to try, by sending a proposal to Congress to introduce payroll tax relief and harmonise VAT among Brazil’s states.
The country’s capital investment rate at less than 20% of GDP is low compared with emerging markets as well as other Latin American economies. One reason is a low savings rate of nearly 15%, compared to well over 30% in China and India.
Another cause of low capital investment is high lending interest rates, with corporate borrowers still charged average interest rates of 31% and personal loans carrying a 45% interest rate. The reasons for these high rates are unclear. History may play a role, although it is unlikely to be the only explanation. Investment is also held back by relatively high taxes on corporate profits and very high tax compliance costs. In addition, private long-term capital markets are needed to bring capital to investors. Reforms in these areas could help boost investment. Brazilians with modest incomes do save, but less eagerly after the age of 40. Why the loss of momentum? Expectations of generous pension benefits have created little incentive to save for many. But like other emerging-market economies, Brazil will age rapidly, and the strain on public finances is going to be felt as the working population shrinks. Although less than 7% of the population is today over 65, that figure is expected to soar to 38% by 2050. The government could nudge people to save by introducing a minimum retirement age and toughening restrictions for those who choose to retire early.
There are three other long-term structural challenges worth highlighting which the government is not shirking from: one is poverty, whose incidence has been declining but is still high; the second is education, where Brazilian children are improving according to international benchmarks, though more effort is needed; and the third is the environment, in particular forestry. Reducing poverty remains one of the government’s top priorities, led by programmes such as Brasil sem Miséria (Brazil without Poverty) and its predecessor Bolsa Familia (Family Grant), and this could ultimately help raise savings. Further progress in poverty reduction could be made by directing more resources to the successful Bolsa Familia cash transfer programme.
Expanding education is paramount in raising the incomes of the poor, as well as improving future competitiveness and growth in the long run. Brazil has made impressive progress in this area over the past decade: while only 30% of the labour force had completed secondary school in 1993, this share stands at 60% today. Student performance has also improved, and the country has moved from being one of the lowest performers in the OECD PISA international assessment of 15-year-olds to being something of a model of the kind of improvements that can be achieved.
Brazil’s identity has a sylvan quality: the country owes its name to a rich redwood and is home to one of the world’s richest and most expansive tropical forests. In June, the Rio +20 summit will mark two decades since the first groundbreaking earth summit of 1992, which helped raise awareness about biodiversity loss and gave political impetus to the concept of sustainable development.
On the ground, balancing environmental and development needs will inevitably be a delicate act in emerging economies such as Brazil. Nevertheless, the government has made tangible progress, thanks notably to a two-thirds reduction in deforestation, which is the main source of Brazil’s greenhouse gas emissions. The country is now on track to meet its emission-reduction targets in good time. It seems certain that those returning to Rio for the Earth Summit will notice a far better-off and more confident country than the one they visited 20 years ago. But, with success expectations will rise, and as in the Olympic high jump, so the bar Brazilians set for themselves will be raised too. Lyndon Thompson
OECD (2011), OECD Economic Surveys: Brazil, OECD, Paris.
Martins, J. O. and T. Price (2001), “Brazil: more than just potential”, OECD Observer, Paris.
“Infrastructure: Not just a sporting challenge”, OECD Observer No. 287.
©OECD Observer No 287 Q4 2011