Brazil At the Crossroads

Brazil's Vice President Michel Temer (L) looks on near President of the Brazilian Senate Renan Calheiros (C) and opposition S
Brazil's Vice President Michel Temer (L) looks on near President of the Brazilian Senate Renan Calheiros (C) and opposition Senator Aecio Neves (R) of the Brazilian Social Democracy Party (PSDB) during a meeting in Brasilia, Brazil April 27, 2016. REUTERS/Ueslei Marcelino TPX IMAGES OF THE DAY


By Otaviano Canuto, Samuel George and Cornelius Fleischhaker Video Content by Samuel George

With the impeachment of President Dilma Roussseff being sent to the Senate on April 17, Brazil continues a period of turmoil that has lasted for more than a year now. With images of protests, counter-protests and the minutia of the country's legal proceedings blasted by media outlets around the world, it seems important to take a step back and remember that a lot more lies beyond the headlines.

Over the last 20 years, Brazil has taken crucial strides towards achieving its weighty, if elusive, potential. Finance minister (later President) Fernando Henrique Cardoso's Real Plan established a stable macroeconomic foundation in the 1990s, which allowed his successor, President Luiz Inácio Lula da Silva, to preside over a growing economy and implement social programs. This combination lifted upwards of 40 million people out of poverty in the first decade of the 21st century (Canuto, 2014).

Strong growth gave Brasília fiscal leeway during the global financial crisis; an aggressive stimulus package in 2009 led to claims that Brazil was the last country in and first country out of the Great Recession. Investment poured in and many wondered if a new day had finally dawned for the perennial "country of the future".

And where are we now? In recession, Brazil's economy contracted by 3.8 percent in 2015, and that figure could be matched in 2016. Inflation hit 10 percent by the end of 2015, although declining this year, and the fiscal deficit has also reached double digits. These economic challenges could be addressed by with decisive policy reforms, but a political crisis, fueled by mushrooming corruption scandals, has led to complete government gridlock.

The fissures run deeper than any one political party, and they will not be resolved with the retention or dismissal of any one particular politician. Brazil has reached a decisive moment; the country is at the crossroads. The Economic Crossroads

Brazil's economy, the envy of the world in the 2000s, has performed poorly since 2011, contracting since late 2014. In essence, Brazil's growth model--one which ran so smoothly during the boom years--was built primarily on consumption, as well as the misguided notion that a commodity "supercycle" brought permanently high prices for Brazilian raw materials such as iron ore, soya and petroleum.

Both precepts proved shortsighted. A consumption-fueled growth motor can run out of steam quickly especially if it is based largely on expanding consumer credit and not backed by improving productivity. Commodity prices, meanwhile, have cooled significantly (Canuto, 2016).

Turning away from the more interventionist policies implemented in her first term, Rousseff tried to restore economic order after her reelection in late 2014. Under Chicago-trained Finance Minister Joaquim Levy, the government attempted to cut back spending and increased artificially low prices for electricity, fuel and public transport, leading to increased prices and stoking inflation. At the same time a corruption scandal engulfing the oil and construction industries resulted in collapsing investment and mass lay-offs. Inflation and job losses reduce confidence and consumer spending, and the falling retail sales lead to further job losses in services and manufacturing: Unemployment topped 10 percent in the first quarter of 2016.

Arguably, the greatest challenge facing the Brazilian economy is fiscal. Declining revenue and the inability to cut rigid spending are driving up the public debt, further undermining confidence. Brazil already spends as much on pensions as do many European countries. But Brazil is still relatively young, though aging fast. If the pension system is not reformed, spending will grow exponentially as the number of seniors rises faster than that of working age people. Simply put, Brazil cannot afford that.

And here we arrive at the crux of the issue. The fiscal problems have policy remedies. Yes, they are difficult ones that would require significant political leadership. But they do exist. Unfortunately for Brazil, the political crisis has brought the system to a gridlock.

The Political Crossroads

If the economic crisis seems tough, the political one is even more intractable. Regardless of what happens in the coming weeks, the Brazilian political system will remain preoccupied with high-level infighting, making progress on any critical policy action dependent on the political stabilization.

The combination of the economic crisis, broken election promises and revelations of pervasive corruption surrounding big-name politicians and Petrobras has reduced the president's approval ratings to single digits. The opposition has reacted by moving toward impeachment, using the relatively minor crime of improper accounting for fiscal expenditures since 2014 as the legal basis.

However, the political crisis has far deeper roots. Both the brazen nature and scope of the Petrobras scandal underscore the deep-seated roots of graft, fraud and bribery in Brazilian politics--a pedigree not unique to any one party.

Since transitioning to democracy in the 1980s, the political system has splintered into several dozen parties, many without any coherent platform beyond the desire for the spoils of public office. Consequently, Brazilians tend to vote for local strongmen or celebrities as opposed to policy programs, party allegiance is weak, and too many policy makers have been bought and sold.

As a result of finger pointing, the already tenuous coalitions have fragmented, undermining anyone's ability to implement economic reform. The Crossroads Brazil Pt. 3: The Country of Tomorrow, Today

A Silver Lining

So what is the best path forward for Brazil? To build a more durable growth motor: one based on increased productivity. This includes long-term strategies such as sustained attention to the oft-overlooked infrastructure and education sectors. In the nearer term, Brazil could pursue deeper engagement in global trade - a move that would improve lagging competitiveness (Canuto, 2015a).

The statistics don't look good. Politics are at their ugliest since the end of military rule. But, Brazil has a remarkable history of overcoming turmoil: from coups and military rule, to hyperinflation and impeachment crises, the country has faced it all, and the country has always emerged (Canuto, 2015b).

Moreover, there are some important silver-linings to the current storm clouds. On the economic side, the dire state of public finances is providing the needed urgency for structural fiscal reform, regardless of who will be governing. Both the current finance minister Nelson Barbosa and the vice president's economic proposal entitled "A bridge to the future" recognize the need for deep reforms, including on pensions and strengthening fiscal responsibility.

The political crisis--while painful in the present--will also provide benefits in the long term. Given that President Rousseff is threatened with impeachment over breaches of fiscal rules, future leaders will be careful to obey these laws and to provide greater transparency of public finances.

Finally, the corruption scandal, with its far-reaching investigations and condemnation of both "buyers" and "sellers", should also payoff in the long run. This would come in the form of improved rule of law and corporate governance, resulting in lower risk perceptions. It should also improve competition and market discipline in key sectors, particularly those bidding for public projects. Finally, cutting out wide-spread kickbacks would reduce both public overspending and the notorious Brazil cost ("Custo Brasil") born by the private sector.

Brazil is at a crossroads. But the upside is that the crossroads offers different paths and different options. Brazil retains its tremendous potential. But to reach it, it must pick the right fork in the road.

Otaviano Canuto is an Executive Director at the International Monetary Fund. All opinions expressed here are his own and do not represent those of the IMF or of those governments he represents at the IMF Board.

Samuel George is the Latin America Project Manager for the Bertelsmann Foundation and creator of The Crossroads video series.

Cornelius Fleischhaker is a PhD candidate at the Johns Hopkins School of Advanced International Studies and co-author of Five Steps to Kickstart Brazil.

NOTE: The videos in this text are a project of Samuel George and the Bertelsmann Foundation and do not reflect the views of co-authors Otaviano Canuto, Cornelius Fleischhaker, or their institutions.