Why Did Brazil Underperform its Peers in 2012? Policy.

The end of Q4 brought forward interesting dynamics in the LatAm region: Namely, a sharp deceleration in inflation in every inflation-targeting economy, with the exception of Brazil (although we expected inflation to soothe by year-end in Mexico, Chile and Peru, the deceleration was much stronger than anticipated, and downward revisions to our inflation forecasts could be in order). Most interestingly, while Mexico, Chile, Peru and Colombia enjoyed at- or above-potential growth in 2011 and 2012, Brazil was below potential during the period. Why? I believe this is partly attributable to the countries’ respective policy mixes.

Figure 1: Brazil Well Below Growth Potential, Well Above Inflation Target (%, y/y)

Source: RGE

In 2012, Mexico, Chile, Colombia and Peru boasted: Strong central bank credibility regarding their respective inflation-targeting mandates; clarity and overall predictability over the choice of reserve-accumulation programs and market intervention by central banks and finance ministries; an absence of punitive capital controls; fruitful debate about, or implementation of, macroeconomic reforms; demonstrable respect for private capital and its role in generating growth; a friendly environment for private investment; central banks independent enough to make decisions on technical grounds; and a coherent overall policy mix. The macroeconomic performance of these countries has reflected productive policy stances: Their currencies appreciated throughout 2012; reforms in various fields such as the labor market, fiscal policy, education and energy have been debated or implemented; inflation expectations remain anchored; fiscal accounting has been clear; business and consumer confidence remain high; domestic demand remains robust; and investment (or fixed capital formation) continues to grow.

Figure 2: BRL Management Suggests Clear Target (%, y/y; 30-day moving average)

Source: Bloomberg and RGE

Brazil, meanwhile, has grown increasingly interventionist. The authorities have resorted to a variety of hostile measures in an attempt to engineer a perfect economic state: Volatile and unpredictable capital controls have been implemented to control the value of BRL, price controls (as in the electricity sector) have been enacted to tame inflation pressures and conditionality regarding labor markets has been attached to stimulus in the industrial sector. This suboptimal policy mix has undermined the credibility of both the central bank and finance ministry: Inflation expectations remain unhinged, inflation dynamics have been detrimental to the economy, fiscal targets have been met only with arbitrary accounting exercises, official forecasts have been divorced from reality, and, more importantly, there is a lack of any sort of acknowledgement that the problems the country faces are endogenous.

This lack of policy-making credibility could translate into uncertainty about the future health of the economy, which would in turn discourage private investment, dragging down economic performance in a negative feedback loop. Exogenous factors can only go so far in explaining Brazil’s poor economic performance in 2012: Weak global dynamics and adverse weather conditions affected industrial production, exports and inflation, but regional peers did not exhibit Brazil’s weakness. Look at Chile and Peru, which also saw deterioration in their external accounts, or Colombia, which suffered a deceleration in industrial production, or Mexico, which has had to deal with elevated food prices stemming from exogenous shocks.

Brazil’s underperformance in 2012, which strongly contrasts the performance of its inflation-targeting LatAm peers, is likely underpinned by poor policy making. This year, Brazil’s growth will likely outperform that of its LatAm peers, fueled by stimulus, base effects and short-term investment buffers, although it will remain below potential. As we have stressed, higher growth will be accompanied by higher inflation if underlying factors are not addressed. Brazil has huge growth opportunities, but downside risks swell when macroeconomic management shifts further toward interventionism.

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