Brazil: Seeking Realism

It is inconvenient, if not outright annoying, that most analysts who follow Brazil closely tend to see through the lenses of over-optimism or excess pessimism. Lately, due to a string of dismal economic numbers and fears over the repercussions of a major corruption scandal brewing at the oil giant Petrobras, Brazil's largest company, excessive pessimism has taken hold over the economic commentary and media reports. Reality, as always, is neither here, nor there. It is certainly not the best of times, but that does not mean that the country is headed towards the worst. Restoring growth, especially after wayward economic policies of the last four years, has been a struggle. Currently, the economy is stagnating while inflation remains high, tantalizingly close to the top range of the inflation target (6.5%). Fiscal outturns have been mired in disappointment: Brazil will likely post its first primary deficit in nearly two decades once the results for December 2014 are finally published. Even if the country manages to avoid a deficit, fiscal accounts are weak and adjustment is long overdue. On the external front, a growing current account deficit and lack of sufficient foreign flows to finance it have brought back the old reality of external financing constraints that characterized Brazil over the last several decades, with the exception of two distinct periods: the so-called "Economic Miracle" years of 1968-1973, and the height of the commodity boom between 2003-2008. Both periods of buoyancy and optimism ended with substantial international turbulence, either in the form of oil price shocks during the 1970s, or as an unprecedented financial crisis that held the global economy hostage, in 2008.

With the exception of these two separate five-year periods, when abundant capital flows from abroad allowed Brazil to promote both investment and consumption despite its historically low domestic savings rate, external financing constraints have always been an impediment to sustained growth and macroeconomic stability. Brazil's savings rate currently stands at just about 15% of GDP, one of the lowest amongst its emerging market peers. As a result, in order to restore growth via the resumption of investment, especially in key areas such as infrastructure, the country is once again overly dependent on dwindling external sources of financing. Investor skepticism over Brazil's prospects has grown over the last few years. The government's inability to restore confidence, its series of policy missteps and slippages have eroded the notion that the country was a rising powerhouse, at the cusp of becoming a key player in world markets and global politics. Although the state of the global economy and the legacy of 2008 have not made things any easier for Brazilian policymakers, the country's current problems are primarily the result of its own undoing. Hence the reason for rampant pessimism, especially among Brazilian analysts who have a tendency to focus on their own backyard, often failing to recognize what is happening in other parts of the world. The World Bank's most recent Global Economic Prospects Report tries to set that record straight. Echoing what had already been outlined in the IMF's October 2014 World Economic Outlook, the reports recognizes what some have dubbed the increasing granularity in various economies, the notion that no country has escaped unscathed from the aftershocks of the financial crisis, while suffering in very particular and different ways, as Tolstoy's famous unhappy families. Although the US economy is on the mend, risks remain, particularly since labor market improvements have failed to materialize as wage increases. Income stagnation in the US has raised inequality to alarming levels, as has persistent unemployment in Europe. Japan is facing the possible failure of Abenomics - the aggressive stimulus package implemented by Prime Minister Shinzo Abe - while China continues to slow down gradually as it moves to a growth model that is more focused on boosting domestic demand. Emerging economies that had become more dependent on China are also slowing down, while facing the prospect that the US might start raising interest rates in the not too distant future. The oil price plunge has taken a toll on major oil-exporters, such as Russia, and rising geopolitical risks have added to uncertainties going forward. None of this is new, and yet it is widely overlooked when prospects for the Brazilian economy come under scrutiny. Brazil is certainly vulnerable, but one would be hard pressed to argue that it is much more fragile than many of its peers. This is the proverbial silver lining for the new economic team headed by Finance Minister Joaquim Levy, an experienced policymaker. If Brazil adheres to the course of adjustment that has recently been outlined, strengthening the fiscal accounts, lowering inflation - even if that means not reaching the target of 4.5% quite as fast - and boosting credibility, it may just be that, in a world of still very low interest rates, external financing constraints will be relaxed somewhat. Less binding constraints would allow the country to tap into external savings to finance its investment needs, thus helping to put the economy back on the path to growth. This is not, by any stretch of the imagination, the sort of virtuous cycle that prevailed in the 1970s or in the early 2000s, but it might just be enough to nudge Brazil from its current dark corner. And that is a measure of realism that should not be ignored.