The macroeconomic situation in Brazil in 2008 (just like in 2006/2007) seems so brilliant and better than ever that it is difficult to find discussions about risks and about a deterioration of the economic scenario. As a matter of fact, it seems that the only criticisms come from within the Government (the so-called “friendly fire”) because the Finance Minister and the National Development Bank (BNDES) keep criticizing the Central Bank and the high interest rates. From the opposition itself, practically nothing.
We believe, however, that it is very important – as an exercise of pessimism – to ask ourselves what can go wrong, because unfortunately the world is like that: something might go wrong with Brazil in 2008 or 2009. We are going to neglect of course political scandals, corruption and political tragedies that might affect the good behavior of the Brazilian economy, and try to concentrate on the potentially weak points of the present macro situation, both in terms of the major targets (growth, inflation and balance-of-payments) as well as in terms of the major instruments of economic policy (monetary, fiscal and exchange rate policy).
In the last ten years, the basic real interest rates in Brazil have been systematically in the range of 7% to 9% per year, in contrast to average rates of economic growth of GDP around 2 to 3%. The nominal effective exchange rate appreciated dramatically in the past five years – certainly more than 100% – in contrast to positive rates of inflation systematically in the range of 4 to 5%. Fiscal adjustment in the past few years focused much more on higher taxation than lower government spending. The country is moving to a zero nominal government deficit (including interest payments), but this is being obtained at the same time that public spending is growing much more in real terms than GDP. Consequently, the tax burden is growing substantially, reaching “European” levels.
How is it possible that, in spite of very high real interest rates, a severely overvalued exchange rate, and a big acceleration in Government spending, there is a general feeling that things are moving very well in Brazil?
In other words: for 2008, economic growth is presently considered sustainable at a level of 5% or 6% per year, inflation is expected to stay within the target band of the Central Bank, and the balance-of-payments does not seem to bring any major preoccupation, given the very high level of international reserves (any eventual negative current account deficit can be easily financed by a positive capital account, in addition to excess capital inflows that should add even more to international reserves).
Let us try, however, to revise some arguments. One might very well argue that, with such high real interest rates and such huge tax burden, long-term economic growth will not be sustainable, cannot be maintained. Moreover, one might say that the appreciation of the exchange rate was so great since 2003 that it should have provoked deflation, rather than a 5% inflation, in addition to provoking a slow deterioration of the current account of the balance of payments, through a negative impact on manufactured exports and an authentic import boom of consumer, intermediate and capital goods.
Therefore, one might very well argue that the present good mix of inflation, growth and external accounts is not sustainable. Either inflation will begin to accelerate and/or the balance of trade will revert entirely its trend and/or economic growth will decelerate again in 2009 or 2010, as a consequence of high government spending, a wrong exchange rate, and high nominal and interest rates.
In addition to these domestic negative factors, we have of course a world growth recession beginning to develop, particularly in the USA, and probably leading to declines in prices of Brazilian commodity “exportables” such as soybeans, iron ore, orange juice, etc.
There is no guarantee therefore that nothing will go wrong in the Brazilian economy in the near future. On the contrary, one could argue that the existing “mix” of economic policies will not be able to sustain low inflation, high economic growth and accumulation of international reserves.
For economists who believe that the size of the Government matters in any economy, it is not the same thing to close a public deficit through higher taxation versus lower Government spending. Economists who believe that the level of the real effective exchange rate affects significantly exports and imports are worried about the Brazilian situation, created by an amazing inflow of external capital through short-term and long-term funds.
Furthermore, some economists are surprised by the maintenance of a 5% inflation in the face of a huge exchange appreciation, which certainly should have reduced substantially the price in reais of tradable goods (exportables and importables).
For all these economists, although they recognize a great improvement in economic policies since 1993 (Plano Real), Brazil has been basically influenced in this new century by a lot of luck, including an impressive rise of commodity prices, and by an irrational exuberance or complacency of international investors, who made profits of more than 100% in a few years, betting on the high Brazilian interest rates, with leverage, and without any preoccupation about exchange rate risks.
In 1968-1973, Brazil went through a period of two-digit economic growth and declining inflation (although still “high” for today standards: two-digit levels). Many analysts used at that time expressions like “Brazilian miracle” and “Island of Prosperity”. The good story fell apart in 1974/83. No country is an island of prosperity and there is no new Brazilian miracle. Yes, Brazil adopted much better economic policies in the last 15 years (as compared to the previous 15 years). However, there is no doubt that good luck helped a lot since 2003 (with such a positive external scenario), but this will not stay there forever. The numbers for 2009 and 2010 might be – all of them – worse than 2006/2008: low growth, high inflation, and loss of international reserves. It all depends on the Brazilian economic policies of the second half of 2008 and the external scenario of the second half of 2008.