It´s Not the Economy - It´s Politics Stupid!
Economics and Politics in Brazil - a Tangled Web
By John Fitzpatrick
This is the time of year when the financial community looks back on the previous 12 months and ahead to the coming 12 months. Those analysts who were right in their predictions congratulate themselves and those who were wrong try and come up with convincing reasons why. Generally speaking, economists and analysts run in packs and consensus is the rule. Unlike some politicians who try to massage figures and make over-optimistic projections, the analysts are guided by computer models, indicators and historical statistics. These economists also know that their projections can influence multi-million dollar investment decisions by their employers and clients so they cannot allow political conviction or wishful thinking to intrude. Personally I have never had much faith in indicators and statistics. First of all, they can they be manipulated, as is obviously happening in China at the moment and was the case during the existence of the USSR. Secondly, they are often preliminary and can cause a shock when they are revised. This was case with the GDP figures for the US in the third quarter of this year which jumped from 1.6% in the first estimate to a final figure of 2.2%, well above the market expectation of 1.8%. Thirdly, and most important, they do not adequately cover the informal part of the economy. The black economy in Brazil is estimated at around 40% or even higher depending on who you talk to.
Despite these personal reservations, the views of economists and analysts are essential and cannot be dismissed. One of the advantages the financial journalist based in São Paulo has is the easy access to Brazil´s top consultants, forecasters and analysts. Meetings and seminars are held practically every day with guest speakers and panelists from the government, Central Bank, National Treasury, universities, trade associations and public and privately-owned groups and companies. One of the most interesting of these recent meeting was organized by the Brazilian Bankers Association (Febraban). The theme was "Brazil and the Challenge of Competitiveness" and the speakers included the Treasury secretary, Carlos Kawall, the former chairman of the Central Bank, Gustavo Franco, ex-director of the Central Bank, Ilan Goldfajn, the consultant Raul Velloso and Spanish economist José Juan Ruiz.
The speakers covered familiar ground - how can Brazil improve its record of weak economic growth, reform its costly public pension scheme, reduce interest rates, improve infrastructure, create jobs and end social inequality? Since these topics have been talked to death I would like to highlight some of the more interesting points raised by speakers.
It´s Not the Economy - It´s Politics Stupid!
Treasury secretary Carlos Kawall is a civil servant and, obviously, has to be careful in how he presents his case. However, he stressed an important point which economists often overlook - the political dimension. Kawall made it clear that a key element of this government´s policy is its decision to expand its social program. The main driver is the Bolsa Familia program which now covers 11 million households. This program has been criticized by many observers (few, if any, of whom have ever experienced poverty in their lives) as being just a hand-out which encourages poor families to rely on the state. The hard fact is that this program will continue during President Luiz Inacio Lula da Silva´s second mandate and will need to be funded. Therefore any "economic" reform has to take this political factor into account. Kawall also said that the reforms everyone knows the country needs have to be negotiated in Congress. Once again, this is an obvious point but if you were to believe some of the commentators in the Brazilian press you would think that the country´s economic problems could be solved overnight with half a dozen swift measures. The make-up of the Brazilian Congress, where no party ever has a majority and alliances are essential, means that it is virtually impossible to get the consensus needed for radical reform. Kawall added that this was not the case with the other members of the so-called BRICs (Brazil, Russia, India and China). I think Kawall should have given India its due as a genuine democracy but he was right to point out the difference in making political changes in a democratic country like Brazil compared with in authoritarian states like Russia and China.
Problems of Low Interest Rates
Several speakers referred to the fall in Brazil´s interest rates which are at a record low in recent times of 13.25% p.a. and are likely to continue to fall. These are still among the highest in the world but have fallen consistently over the last year and, when inflation is taken into account, are running at a real rate of around 10.5%. Gustavo Franco said that although everyone wanted interest rates to fall even further, this could bring future problems. Should the Selic rate fall to 6% in nominal terms some pension funds would find their returns falling and they would have no other option available. Since many of these funds have their money "locked up", with the funds being used as compulsory deposits to finance sectors such as agriculture and housing, they would be unable to switch to other investments. This meant that the fall in interest rates would not necessarily result in greater investment, as many observers imagine. Franco said that the privately-owned banks would probably overcome this problem but he was not so confident about the publicly-owned banks.
The Risk of "Mexicanization"
An interesting analogy came from Ilan Goldfajn who said that Brazil ran the risk of becoming "Mexicanized" i.e. achieving "investment grade", thanks to falling interest real rates, but stuck with weak GDP growth. Goldfajn said this was the most likely outlook in the coming years. He also said that "investment grade" would come when Brazil´s foreign debt had been reduced to zero and this could lead to interest rates of 5%. However, he added that the high tax burden would hold back growth to around 3% a year. "This is the situation in which Mexico finds itself - it has "investment grade", low real interest rates but the economy has not taken off," he said.
Vultures and Canaries
Raul Velloso, one of Brazil´s leading experts in public spending, said there were two approaches to tackling the fiscal problem. The "vultures", who were in a majority, wanted tough, unpopular solutions while the "canaries" said the country only needed to grow. Velloso said Lula´s main challenge in his second term would be to change a government structure in which current expenses, such as wages and pensions for public employees, had priority over investments in the infrastructure the country needs, such as railways and power stations. He pointed out that the current government spending - payroll, social programs and interest on loans - was equivalent to 40% of GDP. The tax burden comes to around 38% of GDP and is not enough to finance these costs. This means that there will be few resources available for the infrastructure. As an example of falling government investment, Velloso said the Transport Ministry had invested the equivalent of 1% of GDP annually in building new roads in the 60s and 70s. Since 1991, this investment had fallen to 0.2% of GDP.
View from Abroad
Finally, there was a welcome outside view from a Spanish economist, José Juan Ruiz, head of the Latin American division of Banco Santander. He compared Brazil´s high interest rates with those of other Latin American countries. Whereas Brazil´s real rates are currently at 10.5%, they come to 3.2% in Mexico, 2.5% in Chile and 2.2% in Colombia. He pointed out that real interest rates in Chile had fallen from around 8% in 1998 to zero in 2000 before rising again to their current level. Chile had managed to cut interest rates by opening its market, achieving sustained growth and prudent fiscal policies. As a result, growth had risen from 3.4% to 4.5% and inflation had fallen from 4.6% to 2.8%. However, Ruiz stressed that sustained growth required not just falling interest rates but high investment and a skilled workforce. In this case, Brazil was lagging behind most Latin American countries, he added.
But What Does Lula Think?
The chances of Lula paying any attention to these comments and warnings are slim. He has managed to steer the economy on a fairly steady course over the last four years and is unlikely to change tack now. This is not particularly bad news providing Brazil manages to avoid any unpleasant external shock, such as a huge fall in commodity prices, a big rise in oil prices or a crisis in the US economy. It will be left to Lula´s successor and future generations of Brazilians to tackle these challenges. Should Lula be succeeded by a younger politician like the governor of Minas Gerais, Aecio Neves, then there is a chance that some structural reform will be made. If, however, someone like Ciro Gomes, Lula´s current favorite, takes over then we cannot be so sure.
© John Fitzpatrick 2006
John Fitzpatrick is a Scottish writer and consultant with long experience of Brazil. He is based in São Paulo and runs his own company Celtic Comunicações. This article originally appeared on his site brazilpoliticalcomment.com.br. He can be contacted at jf@celt.com.br.
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