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Encouraging Recovery as Brazil Mulls Changing Budget Target

by internationaldirector

Written By: Morgan Jones – Corporate Finance

Good news reports from Brazil have been few and far between in recent years. Political instability associated with high-level corruption has shaken investor confidence and ushered in the deepest recession Brazil has seen in decades. Adding to Brazil’s worries are the oil-price collapse, which started in 2014, and the end of the commodity super-cycle, as Chinese demand tapers off. Both represent substantial losses to Brazil’s exports and a reduction in economic performance. In June of this year, the country posted the largest budget deficit for the month of June—a total of US$6.21 billion.

All of this coincides with a 5-percent approval rating for interim President Michel Temer, who is currently fending off corruption allegations and maneuvering his way around criminal charges. Daily protests are occurring in a number of major Brazilian cities as citizens rail against corruption and lack of services. However, a number of factors are occurring in concert to improve conditions. Though cautious in his optimism, Brazilian Finance Minister Henrique Meirelles believes there exists the possibility for conditions to improve enough for the budget target to be raised, rather than lowered. Much is due to uncertain events that may take hold within the next year. An improving trade environment, a stabilizing political atmosphere and structural reforms are all cooperating to lift anxieties about the country’s performance. As Brazil goes to the polls in 2018, and the South American trade bloc, the Common Market of the South (Mercosur), inks a trade deal with the European Union (EU), international markets have been encouraged with the possibility for legitimate recovery.

The road to Brazil’s present conditions is long and bumpy. While limited exposure insulated the country from the 2007 financial crisis, the commodity super-cycle fuelled by Chinese demand caused structural shifts that would destabilize the country. While this in itself was not a negative result, it led to decelerated progress in developing Brazil’s industrial and manufacturing industries in favor of its lucrative agricultural sector. Adding to the equation was the generally protectionist policies practiced by Brazil and Argentina—the largest economies in Mercosur—which created a hostile and nationalist trade environment. Moreover, the discovery of large oil reserves off the coast of Brazil saw the country rely, increasingly, on exports of oil in the interim. Rather than introduce necessary structural reforms during Brazil’s fat years, former President Luiz Inácio Lula da Silva and his hand-picked successor, Dilma Rousseff, spent massive amounts on buying votes from the country’s poorer classes. The stage was set.

Brazil was struck—suddenly and sharply—by three major events: the end of the commodity super-cycle, the 2014 collapse in oil prices and the Lava Jato (Operation Car Wash) corruption investigations. First, the 2014 collapse in oil prices saw a substantial drop in the country’s oil revenues, which had only recently comprised a significant portion of Brazilian gross domestic product (GDP). While the collapse did not impact Brazil as heavily as other countries—Venezuela, in particular—the shock then combined with the second event, the end of the commodities super-cycle.

From 2000 to 2014, Latin America gorged itself on commodity-export revenues to satiate Chinese demand. At the time, China was consuming enormous amounts of raw materials produced by many Latin American primary-goods markets. However, 2014 saw China shift focus toward a domestic-consumption economy and end its appetite for South American goods. Thus, oil and agricultural exports suffered considerable downturns in Brazil.

Then came the third shock: the corruption investigations. 2014 also saw the beginning of a widespread and comprehensive corruption investigation into Brazil’s top politicians. Dubbed Lava Jato, the investigations were headed by judge Sérgio Fernando Moro and responsible for the eventual ouster of then-president Dilma Rousseff. Rousseff’s mentor and predecessor, Lula da Silva, also ran afoul of the investigations and was recently convicted and sentenced to serve various years in jail. The interim president, Michel Temer, has not been immune to these allegations or these investigations, and has been embroiled in his own battle for some months.

The culmination of these three structural events was simple. GDP dropped dramatically—leading to disappointing growth. The languishing performance led to political instability that coincided with the corruption investigations, which revealed the level to which the system had been compromised. Investor confidence was severely shaken, and the country entered its deepest recession in more than a decade.

The previously mentioned factors have all led to some patently negative outlooks. Additionally, continued political uncertainty has left the future murky for Brazil as it enters a 2018 presidential election with no clear candidates. However, policymakers believe that the uncertainty could also provide opportunities that lead to a real recovery. At present, Finance Minister Henrique Meirelles believes that well-performing tax revenues could be the key to a strong recovery. This stands to reason, as both structural and political shifts seem to be coming to an end. Recently, Temer was able to shake off a criminal trial over the corruption allegations following a congressional vote. This much-needed victory could be a boon for Brazil, as Temer had been aggressively pursuing a liberalized trade policy—cooperating with Mercosur partner Argentina for the first time in years. Moreover, the continuation of Temer’s presidency means that investors see a reprieve, however brief, from the shaky political situations currently gripping Brazil.

Simultaneously, the Brazilian government opted to redirect $700 million away from investments to pay for much-needed services, such as air traffic control and police services. Subpar services are amongst the grievances currently fuelling the daily protests that plague the government. Additionally, it signals a commitment to structural reform that will lead to less uncertainty and more reliable growth statistics. Ultimately, while the Brazilian budget may need to be adjusted in the near future, it is not certain whether that change will be positive or negative.

Time will tell what changes prevail, but a reliable answer will, most likely, not be provided prior to the 2018 elections.


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