By Maarten Jan-Bakkum
Few emerging economies have such poor growth record as Brazil. After having grown at an average rate of only 1.5% in the past two years, the Brazilian economy is now likely to enter into a recession again. In Q3, GDP contracted and from the available data for October and November we can deduct that Q4 growth is likely to be negative as well.
Brazilian growth is likely to continue facing serious headwinds in the coming quarters and years. In the short term, the only positive driver is the decline in food price inflation, which has a positive impact on disposable incomes and should, therefore, help household consumption. Otherwise, we see only negative growth drivers. Six stand out. Firstly, the industrial sector which is by far the weakest link in the economy. The interventionist policy mix, lack of supply-side reform and regulatory uncertainties created by the Dilma administration have eroded competitiveness and killed the appetite from the private sector to invest.
Secondly, the labour market, which has been strong for eight years, is now starting to level off. New jobs are still being created, but half as many as the 10-year average. As a result, the unemployment rate has stopped declining. Real wage growth is still in positive territory, despite high inflation, but should decline in the coming quarters, as the labour market is becoming less tight.
A substantial positive contribution from household consumption, as we have seen in the past eight years, can no longer be expected. Consumer leverage – and this is the third headwind to growth – peaked in 2012. Private banks have become more cautious and consumer debt as a percentage of income, which doubled to 30% between 2005 and 2012, has stopped rising. While private banks have tightened credit standards, the public banks have continued to increase their loan book at 20%-plus annual growth rates. But also here, the prospects for growth have deteriorated, as the government is considering reducing its transfers to the public banks. The government appears sensitive to recent threats from credit rating agencies to downgrade Brazil because of the rapid growth of its gross-debtto- GDP ratio.
The fourth headwind to growth is the fiscal position. After years of expansionist policies, the primary fiscal surplus has evaporated to less than 1% of GDP, from 4% only two years ago. With the currency already under pressure and with credit rating downgrades coming closer and closer, the government has very little room to manoeuvre.
The fifth negative for growth is monetary policy. The city protests of this year made clear to the government that the biggest immediate risk for re-election is higher inflation. This explains partly why the central bank has been so hawkish in recent months, hiking rates by no less than 225 basis points. Of course, the market pressure on the country due to the US tapering fears, played a big role as well.
With credit growth already under pressure due to more prudent private banks and the government intentions to provide less fresh capital to the public banks, it will likely be pushed down even more by the higher interest rates.
The sixth problem for growth is exogenous: the likely further deterioration in Brazil’s terms of trade. During the China boom years, investment growth in Brazil was strong, mainly in the mining and energy sectors. However, the BRL is likely to feel the pressure from deteriorating terms of trade. This should mean that interest rates will be higher than they have been in the past few years. Both fixed investment and household consumption growth will feel the resulting decline in credit growth.
Brazil urgently needs meaningful labour and fiscal reforms, decisive action to allow more private investment in infrastructure, credible steps to reduce the role of the public banks, a more predictable, less interventionist regulatory environment. This kind of steps would help to bring the equilibrium back in the Brazilian economy and would increase the growth potential and reduce the imbalances.
Maarten Jan-Bakkum is senior emerging market strategist, ING Investment Management
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