This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Eduardo Jarra, HSBC's head of macro research and strategy for Brazil, weighs up the county's prospects.
Not so long ago, headlines about Brazil mostly revolved around its strong growth and future prospects. However, nowadays headlines seem to focus more on disappointing economic data and problems impacting the country’s prospects.
We believe that the true picture has elements of both: perspectives are not as rosy as perceived in the past but also not as negative as currently believed. If this is a reasonable view, one could expect a future path that will show some improvement, especially in terms of economic growth, probably accompanied by heated discussions regarding future challenges.
To make things more complicated, investors must deal with two critical themes. On the external front, the global scenario now looks more challenging for Brazil, with higher global interest rates following the recent sell off in global bond markets and Chinese growth that is unlikely to return to the heady levels of the pre-crisis period; in other words, less favourable conditions in terms of external financing and commodity prices. On the domestic side, presidential elections are scheduled for next year on the back of modest growth and high inflation, hardly a supportive backdrop for necessary economic reforms and structural adjustment.
Taking a balanced view, there are also some key positives. The country has benefited from several structural advances during the past couple of decades, increasing the resilience of the economy and creating important engines for future growth.
From 2004 to 2010, the Brazilian economy achieved an average growth rate of 4.5%. This was impressive for a country used to growth of close to 2% in previous years. Of course, this was also a favourable phase for many countries, including Brazil’s neighbours in Latin America.
Several factors led to this. On the external side, the trade balance posted a solid performance, hugely supported by commodities. At the same time, external financing was abundant, with foreign investors happy to invest in both the real and financial sectors of the economy.
This was also the phase where the country reaped the dividends from reforms implemented since the Nineties. For instance, credit growth accelerated, providing large parts of society with access to goods and services not affordable to them in the past, including cars and housing. The government also had the opportunity to improve its social programmes, such as welfare payments, increasing the minimum wage, and there was also a dramatic reduction in the unemployment rate. Against this backdrop, it is no coincidence that confidence among businessmen and investors was generally high, with substantial growth in productive investment as a consequence.
However, on the negative side, during this period the administration virtually halted economic reform, and this has created a constraint on economic expansion in the coming years.
Since 2011 the macro landscape has changed. Economic performance has been disappointing with GDP growth on average at 2% and inflation remaining stubbornly above the middle of the target range, currently at 4.5%. If our scenario happens to be correct, 2013 and 2014 will tell a similar story. By regional standards, this has also been a disappointment. To some extent, this is a natural consequence of the international scenario, but this picture also reflects important domestic factors.
First there is a fading impact of the drivers that propelled the economy during the previous years, which can be considered a natural stabilisation, not a reversion of the trend seen within credit, the labour market, social programmes and other areas. This means that the economy could not have kept growing simply as a result of a focus on consumption and commodities.
Second the lack of structural reform and infrastructure investment since 2004 has led to a loss of competitiveness, not to mention an important driver of growth rates in the short term.
Finally, the policy strategy adopted during these years did not help. Policy stimulus through interest rate cuts, despite high inflation, was accompanied by fiscal and public credit expansion. The consequence has been to reduce confidence, push up inflation and curb real income expansion.
The Future of Brazil
The question now is: can the country return to a more virtuous path? For that, economic growth must accelerate without adding to inflationary pressures and there needs to be a more balanced macro-economic framework.
There are grounds for hope. Although on a cyclical basis commodities are weaker, prospects for the long term are still positive, with Brazil in good shape to be a key supplier of hard and soft commodities and benefit from related investment in production and infrastructure. Domestic demand also has several positive drivers for future expansion. Consumption is likely to continue on the back of rising and better distributed income. In terms of investment, there is strong consensus on the need for improved infrastructure. The message here is straightforward: the country does not need to leverage to grow, only to create conditions for this potential demand to materialise over the coming years.
This leads us to the key tasks for the coming years. First, it is very important to rebalance the macro landscape, bringing inflation back to target. This will require a more restrictive policy, especially on the fiscal and credit side, despite the short-term impact this would have on activity. If this is done, it should lead to an improvement in confidence.
Then there must be a clear strategy to generate economic growth. Our view is that the focus should no longer be only on consumption and commodities, with the key to unlock the economy lying with investment, especially in infrastructure. This is an area of huge pent-up demand as mentioned above and more investment will mean more potential GDP growth in the future. It is also important to note that the Brazilian manufacturing sector faces a challenging external environment so any structural support is not only welcomed but, arguably, required.
There is a substantial agenda for boosting both investment and productivity. Some reforms will necessitate far-reaching discussion within society, especially those related to taxation, public expenditure, the pension system and labour market regulation. Others depend on the strategy and design adopted by the government being aligned with investor interests; for example, on privatisation and changes in legislation.
For us it seems that the perception about the Brazilian economy was overly bullish in the past and that the pendulum has now swung too far in the direction of excessive pessimism. Indeed, Brazil faces key challenges without easy solutions. However, there are still reasons to be optimistic, including the lasting impact of reforms implemented in the past and potential future demand from different sectors of the economy.
The crux of the challenge is to unlock growth by adjusting the policy stance and pushing some advances on the macro or micro agenda. It is not an easy task, but our perception is that the in-coming government following elections next year will start to tackle these issues. High inflation is definitely a liability for any government, especially in Brazil. So an even more restrictive policy stance is a reasonable strategy. Meanwhile enduring slow economic growth is complicated for a country with a young population that needs jobs creation on a sustainable basis. So it is in the best interests of policy makers in government to make adjustments to improve future growth prospects.
