Brazil’s economy—while it still confronts structural and policy challenges—has a solid medium-term outlook. It’s true that the economic boom, which has made Brazil the sixth-largest economy in the world, coincided with higher commodity demand, brought about by the growth of emerging economies in Asia.
But Brazil’s recent success cannot be attributed just to commodities.
Higher commodity prices lifted Brazil’s terms of trade and contributed to the appreciation of the real. As a result, Brazilians’ purchasing power increased—as did per-capita GDP, from $3,700 in 2000 to $12,400 last year—reinforcing domestic demand. Commodities also increased as a share of Brazil’s exports. If managed properly, its diversified commodity export base that comprises agriculture, metals and energy (all fitting neatly with the needs of emerging Asia) will remain a fundamental strength for Brazil’s economic outlook.
The seeds of Brazil’s economic turnaround were planted well before the shift to higher growth in 2004 and can be traced back to Brazil’s transition to democracy under the 1988 Constitution. In addition, domestic policy decisions over the past two decades enabled Brazil to take advantage of favorable global conditions to unlock stronger growth for Brazil’s domestic market.
Democratic stability has flourished under this constitution, underscored by the transfer of power to Luiz Inácio Lula da Silva in 2002. The resulting sense of stability for the Brazilian private sector is hard to quantify, but it unleashed a confidence that “rules of the game” were secure. These rules include an updated, consistent policy framework engineered during the Fernando Henrique Cardoso era.
The establishment of the Real Plan in 1994 tamed a legacy of high inflation, and was followed by a series of key economic policy changes that strengthened the resiliency of the economy, including inflation targeting and the floating exchange rate regime of 1999.
Fiscal policy turned a corner in the fourth quarter of 1998 with established fiscal targets, bolstered by a fiscal responsibility law and stricter parameters for the states’ finances. While these rules have not been implemented to the letter, a stronger fiscal balance sheet at both the federal and state levels and a spirit of fiscal responsibility remain in place. Net general government debt has declined by some 20 percentage points to about 40 percent of GDP, with a less vulnerable composition, since 2002.
The overhaul of Brazil’s banking system in the 1990s and 2000s, which included closing states’ banks and stronger supervision and regulation of the private and government-owned banks, was key. As the current global crisis underscores, sound banking systems are a prerequisite for solid growth.
No doubt a critical element of Brazil’s turnaround is the marked reduction in its net external debt from over 200 percent of exports of goods and services in 2002 to a negative position in 2009. This stronger external balance sheet provides a key buffer for Brazil to weather global shocks.
All these policy improvements engendered a firmer foundation for broader-based domestic demand-led growth. Almost 40 million Brazilians moved up to the middle class. Lower poverty and inequality, which hit a 50-year low in 2011, broadened Brazil’s consumption base beyond the upper-middle class. Bolsa Familia, while reaching about 50 million Brazilians, accounts for only 0.4 percent of GDP and cannot take credit for the turnaround in social indicators.
Solid (at times, too high) minimum wage growth and low inflation have been crucial. Most important, though, was the over 17 million formal jobs created between 2003 and 2011. Unemployment dropped to about 6 percent in April; less than half what it was in 2003.
At the same time, better macroeconomic conditions—alongside microeconomic policy decisions that eased access to collateral—facilitated credit growth, particularly for these newly formally employed Brazilians (and companies). Credit doubled to about 50 percent of GDP today, contributing to firmer domestic demand.
Brazil’s growth is likely to slow from pre-Great Recession rates of 4.8 percent (2004 to 2008), and already averaged 3.2 percent from 2009 to 2011. Brazil cannot escape the sluggish growth trajectory of advanced economies, the downshift in growth in emerging markets (especially China), or the concomitant moderation in commodity demand.
This lower growth, however, also reflects domestic bottlenecks in the economy. Growth potential of around 3 percent to 3.5 percent is comparatively low for an emerging economy. Investment remains under 20 percent of GDP.
Brazil’s real interest rates are still among the highest in the world and reflect distortions in the credit market. Availability of skilled labor is increasingly under pressure in a tight labor market. Inflation, while meeting established targets (4.5 +/– 2 percent) has ticked up in the past several years, and non-tradable inflation is closer to 8 percent. The pace of credit growth is likely to moderate, slowing consumption and investment.
The current strain on Brazilian industry, in particular, illustrates Brazil’s commodity- and non-commodity-related challenges. After a quick rebound in 2009, industrial production moderated in 2010 and contracted by an average 1.7 percent per month (year-on-year) from mid-2011 through March 2012, despite strong consumer demand.
Indeed, imported consumer durable goods as a share of total imports almost doubled in 2012, from 6.5 percent in 2006 to 10.6 percent in 2011, as industry lost competitiveness. This can be attributed partly to the appreciation of the real, but also to higher unit labor costs, which climbed 170 percent between April 2004 and 2012. Industry would be well served by a medium-term policy focus that addresses longstanding constraints on growth with a less distortionary (and potentially lower) tax burden, better infrastructure, and greater supply of skilled labor.
It’s also not so clear by how much the real is overvalued—or how long that will last. Part of the appreciation is related to Brazil’s sounder economic fundamentals, not just high real interest rates in Brazil and commodity links. That said, higher oil production in the coming years will reinforce the tendency for appreciation of the real with a rise in commodity prices. Hence, it is all the more important for policy to address these other constraints on growth that weigh on competitiveness and higher rates of broad-based growth.
Over the past two decades, Brazil has already demonstrated its ability to establish the rules and institutions that can put policy on sound footing. It must do so over the coming decades as well to sustain this growth spurt.