Is Brazil Ready to Rebound?
Brazil may be poised for an economic recovery.
That may be hard to believe with the country in the midst of a harsh recession, inflation running at 8% or so, a wave of ongoing corruption scandals, weak commodity markets, and the national currency — the real — plunging roughly 62% from its peak in 2011 to its trough in 2015 and a long way from recouping those losses. But the mood at the Sixth Annual CFA Society Brazil Conference in Sao Paulo was hardly downbeat.
Though sentiments were measured, on the whole the atmosphere was hopeful.
Conference speakers Caio Megale, an economist at Itaú Unibanco, and Christopher Garman, a political scientist and managing director at the Eurasia Group, both struck a similar chord: While many developed markets are crippled by poor demand, Brazil suffers from excess supply. Because the country’s demand growth remains stable, both Megale and Garman anticipate Brazil will grow out of its present challenges.
Megale painted a compelling portrait of the global macroeconomic environment in which Brazil now operates. Unlike years past, developed markets have failed to recover from recession. Yes, they are growing, but traditionally countries recoup all the losses from a recession and then resume trend-line growth. That has not been true this time around. In fact, in a rather ominous sign, developed markets crashed and then grew from the lower plateau, and growth is now more tepid than before the crisis, moving a complete recovery even further out of reach.
While Megale was cautious about offering an explanation for these developments, he leans toward the secular stagnation hypothesis articulated by Larry Summers. According to this theory, unfavorable demographics and income inequality are inhibiting growth. Growth itself is a function of credit bubbles, and so will resume only when deleveraging and borrowing headwinds subside.
What is fascinating is that developed and emerging markets have been virtual mirror images of each other when it comes to leveraging since the economic crisis in 2008. Government debt in developed markets has increased sharply as a percentage of GDP: rising from about 75% in 2008 to about 115% today. Credit to the private sector in developed markets has declined fairly significantly — reaching a peak of about 145% of GDP in 2009 and falling to about 128% today — moving from about 40% of GDP in 2008 to roughly 47% today.
In contrast, there has been no meaningful change in the levels of government debt in emerging markets, while private sector debt has simply exploded — soaring from about 75% of GDP pre-crisis to about 138% just eight years later.
Focusing on Brazil’s economy, Megale said the country depends on commodity production, so it remains sensitive to commodity prices and volumes. With commodity markets still sluggish, this will act as a drag on growth. Amid the worst recession in Brazil’s history, he also highlighted the obstacles that remain: falling retail sales, declining industrial production, and fairly high inflation, among them.
Nevertheless, Megale stressed several reasons for optimism. The Brazilian real has appreciated roughly 25% in 2016. Also, the lower house of congress recently passed a bill that limits federal government spending, placing a cap on government outlays and potentially reining in the country’s reliance on government debt. Business and consumer confidence are rebounding. Also, unit labor costs are falling quickly, he said, having declined from 116 to about 101 in the past 12 months alone. Megale suggested that this fact more than any other bodes well for a Brazilian rebound in 2017.
He also expects Brazil’s central bank to loosen monetary policy by dropping the benchmark SELIC rate from 14% today to about 10% by 2018, creating another powerful tailwind to potentially offset the present recession.
Garman’s perspective differed dramatically from Megale’s, but he drew similar conclusions. He began his discourse with a review of events in developed markets, where political developments represent a stark departure from the past. A growing and healthy middle class is a harbinger of stability historically. Unfortunately, current trends in the United States and Europe suggest that the middle class is under strain. This has resulted in resurgent nativist sentiment — as certain segments of the population express alienation in the face of demographic shifts — and reflects underlying discontentment and insecurity.
The vote in the United Kingdom to exit the European Union is a dramatic illustration of this phenomenon. While Garman thinks the potential for further departures from the EU remains contained, a prolonged Brexit process will amplify other risks. Indeed, in Italy three quarters of the population agree with the statement “More and more, I don’t identify with what my country has become,” and Italian voters just rejected a proposal favored by EU officials and the country’s political establishment to reform the national constitution. The dissatisfaction suggests that the potential for meaningful change exists, according to Garman, though he stopped short of predicting Italy’s exit from the EU.
In the United States, similar populist sentiment is widespread. Roughly 56% of the population feels like immigration and globalism reduce employment opportunities. In turn, such undercurrents will hamstring proposed trade deals, such as the Trans-Pacific Partnership (TPP). In general, large economies are increasingly looking inward, which magnifies geopolitical risk.
In emerging markets, the rising middle classes are increasingly concerned with improving education and quality of life. Ironically, citizens are now demanding more from politicians at a time when politicians’ ability to deliver is declining.
Focusing on Brazil, Garman said that the new Michel Temer government has slightly more public support than that of the recently impeached Dilma Rousseff. But corruption scandals have rocked the country and engulfed its political class.
Still, the passage of the bill to limit government spending was well-received, helping to bolster the fledgling government. In fact, the spending cap came up often in conversations at the conference. The government is also set to tackle pension reform in early 2017 as well. So the Temer government may be in a position to address some of Brazil’s most pressing structural problems.
In the final analysis, the harsh recession of the past two years is paving the way for much-needed political reform and economic adjustments in Brazil. Considerable progress has been made already, and with steady growth in domestic demand, both Megale and Garman are optimistic that better days lie ahead.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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