Brazil’s slow rise from the ashes

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From hero to zero
When Guido Mantega, Brazil’s former finance minister, proclaimed in 2010 that Brazil had entered a global currency war he gained personal fame for a day, but destined his country for a demise
that continues to this day.

Mantega’s comments were followed by a number of regressive economic policy changes that quickly shunted the country into a policy realm reminiscent of Brazil in the 1950s and 1960s, including taxes on capital inflows, price controls, irresponsible fiscal policy and excessive political interference with the central bank.

The results were predictable: business confidence declined, stock markets drifted lower, foreign investors pulled out, the currency weakened, inflation began to rise and finally growth began to weaken seriously. The economic conditions deteriorated so rapidly that President Dilma Rousseff barely won re-election in mid-2014, a truly remarkable decline given that she had inherited a strong and confident Brazil only five years previously.

Putrid Petrobras
The problems did not end there. Soon after her re-election, Dilma found herself and other members of her administration the targets of legal and media allegations of their involvement in a major
corruption scandal that hit Petrobras, Brazil’s largest company.

Today, it is widely recognised that the problems at Petrobras are of a scale that qualifies the case as a textbook lesson on how not to govern a state-owned enterprise. The company’s top management positions were filled with politicians and their appointees seeking to extract rents from large contracts rather than technocrats focused on the company’s core mission to develop Brazil’s vast energy resources.

Given insufficient capital for prudent investment, the company’s profitability was further compromised by ever higher subsidies on gasoline and diesel prices introduced by Mantega. Petrobras was also forced to source inputs locally, despite the local industry being incapable of delivering the specialist goods and services needed for oil exploration at competitive prices.

Thus, when the news broke that officials in key executive and board positions had lined their own pockets to a mind-boggling extent, this was but the last in a long line of problematic government interventions undermining Petrobras.

The political basis for a turn-around
Ironically, Dilma’s political survival with the slimmest of mandates in the election of 2014 may have been the best thing to happen to Brazil amidst the macroeconomic malaise and the erupting
scandal at Petrobras.

Arguably, an opposition president without control of parliament would have struggled to pass reforms, whereas Dilma and the PT party now found themselves with few options other than to reach across the aisle, both to fix the economy and to fend off the growing risk of impeachment over the Petrobras scandal.

Brazil’s political opposition, as it happens, understood the large problems created by the fiscal erosion. Pursuing an agenda to resuscitate the depressed businesses sector, opposition politicians eyed the possibility of a deal.

The result was a political agreement whereby the government committed itself to a two-year fiscal adjustment and reform programme in exchange for a promise of ‘immunity’ from impeachment from the opposition. A new finance minister with an unquestionable mandate to adjust the public accounts, Joaquim Levy, has been appointed to lead the reform effort, while the central bank has restored its focus on pursuing the inflation target.

Political power shifted away from Dilma and PT towards the PMDB party, which now ‘calls the shots’ in the legislature, albeit behind the scenes to escape the political fallout from adjustment.
All sides, perhaps with the exception of PT, stand to gain from this deal. Brazil’s companies will soon be back in business, which helps the opposition, while Dilma has reasonable hopes of political survival.

The PMDB has real power as long as the current arrangement remains in force.

Still, the next year or so will not be smooth sailing. A battle to assign political blame will accompany each adjustment measure. Deals must be struck and heads may roll. Ultimately, the political
deal is destined to fall apart, probably in late 2016 or early 2017.

But by then Brazil’s economic fortunes should look much better. Dilma will hope that the worst of the heat from the Petrobras scandal will have subsided to allow her to serve out her term,
helped by returning growth. Her challenge in the intervening period will be to carry with her the support of the PT through the tough period of fiscal consolidation.

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