Brazil is in a tough spot. Led by weak investment and plummeting confidence, growth, after slowing markedly since mid-2013, came to a virtual halt in 2014. This largely reflects the impact of diminished competitiveness, the erosion of policy credibility, owing to a persistent deterioration of fiscal outcomes and above-target inflation, and a worsening of external conditions for the country.
Risks to the outlook are significantly to the downside, and include adverse ramifications from the ongoing corruption probe concerning Petrobras, the possibility that fiscal policy goals may not be fully met, and energy and water rationing.
External downside risks emanate from a tightening of global financial conditions, geo-political tensions, and contagion from adverse developments in other emerging economies.
These risks could conflate if they were to combine with domestic policy shortfalls, and would threaten macro and financial stability.
The phrase, “threaten macro and financial stability,” is official-speak and central-banker jargon for a resounding economic and financial crash. It’s Brazil’s doomsday scenario.
This was written not by some doom-and-gloomer, but by the IMF. It’s how its report on Brazil starts out.
The report never mentioned “austerity,” the classic IMF prescription to make sure the teetering country’s sacred bondholders – mostly financial institutions – don’t end up holding the bag. “Austerity” has become object of derision. So the report bandies about the exact synonym, “fiscal consolidation,” after initiating it promisingly:
Fiscal consolidation should proceed without delay along the announced lines, while monetary policy should remain tight to bring inflation to target.
State-owned Petrobras, the country’s largest company, the once shining knight and in the once most promising industry, has been torn apart by corruption allegations that go all the way up the political ladder. And things have essentially ground to a halt.
Financing is already tough in the energy sector. But for Petrobras, it has gotten even tougher. If it cannot access the markets, it will have to go begging to the government. But the government doesn’t have the money and is undergoing “fiscal consolidation.”
The report adds a flair for the economic domino theory:
Adverse spillovers from the corruption probe could be large. The probe involves several of the largest construction companies in Brazil. At present, 27 such companies have been banned from engaging in new contracts with Petrobras. As already seen in one case (OAS), these companies may face difficulties securing financing, possibly impacting their suppliers and creditors.
The World Cup didn’t change anything other than making Brazil’s fiscal problems worse by digging a deeper hole that now requires “fiscal consolidation.” But the media has a field day discussing the “white elephant stadiums and unfinished infrastructure projects”:
The most expensive World Cup stadium – located in the capital, Brasilia, and with a price tag of $550 million – is being used as a parking lot for buses.
The stadium in Cuiaba – which cost some $215 million to build – has made news repeatedly: first for being closed down because of faulty construction, and then recently for the homeless people squatting in its unused locker rooms.
That’s the curse of these kinds of glory events. The Olympics had been the final kick that pushed Greece over the cliff. Oh wait. Next year, the Summer Olympics will be held in … Rio de Janeiro.
And then there’s the water shortage. Not like in California, where we have a drought that is difficult to deal with, but for urban residents at least, water still comes out of the tap. That’s not assured on a daily basis in Brazil.
Instead of blowing money on grandiose stadiums and corruption, Brazil should have invested it in water infrastructure projects.
So the new Finance Minister Joaquim Levy, in order to fill the gaping hole left behind by the World Cup and years of stimulus and decades of corruption, is trying to cut the budget and extract higher taxes – “fiscal consolidation.” It’s not going to work. But he’s trying bravely.
Inflation is running loose, and the central bank is raising rates to tamp down on it. The economy shrank in the Q3 2013 and has since gone nowhere. The IMF predicts that GDP in 2015 will contract only 1%. That’s the optimistic scenario.
At the same time, Brazil faces external risk: China, its crucial trading partner, is slowing down and imports into China are plunging.
In the US, the Fed has stopped QE and has kicked off a cacophony about raising rates. When these rate increases kick in, capital flows will reverse, and “hot money” will evaporate from Brazil, perhaps overnight, triggering a liquidity crisis, unless Brazil gives this “hot money” reason to stay. And that may be tough.
Those are among the things the IMF is fretting about.
Here are two charts that the IMF didn’t include in its report – true doom-and-gloom charts of industrial production, which has been shriveling for seven quarters in a row, and of industrial and consumer confidence, which have collapsed. Note that industrial confidence has reached the lows of the Financial Crisis: