Brazil: Heading Towards Recession

Global Finance sat down with José Francisco de Lima Gonçalves, a professor of economics at São Paulo University and chief economist at Banco Fator, to discuss his views on Brazil in 2015. He was an adviser to the Ministry of Finance (1991-1992) and director at the National Treasury (1986-1987).

José Francisco de Lima Gonçalves: I do think Brazil will be in recession in 2015, with the gross domestic product contracting as much as 1.5%. I revised my forecast in February from a more modest fall of 0.5%. Private consumption will grow much less than in the past—at around 1%—because the labor market is already showing clear signs of deterioration, inflation is rising and credit expansion is losing momentum. Investments are likely to contract by about 4% under the hypothesis that electricity will be cut by 5% during the current drought. Should power rationing caused by water shortages be more severe, investments could fall as much as 8%.

Global Finance: Finance minister Joaquim Levy has already raised taxes and limited public expenditures to correct a public sector deficit that doubled last year to 6.7%. More measures are needed, but Congress has demanded the right to approve cuts in unemployment and pension benefits. How likely is it that these unpopular measures will be approved?

Gonçalves: This political issue is crucial, and at the same time it is very difficult to assess. The Congress in Brazil is relatively distant from ordinary people, and this allows for some negotiation between congressmen and the government. Inaction could be fatal, and I do expect some measures to be approved. However, I’m really concerned about ordinary people, myself included. Our conditions improved a lot during the heydays, and now I don’t know how people will react when measures that contain public spending cuts are approved. This is an un-precedented situation, and there is a clear risk of popular frustration. [On April 8, party leaders in the ruling coalition signed on to the government plan to reduce the deficit.]

GF: How do you read the decision announced by president Dilma Rousseff in April to hand formal responsibility for negotiating with Congress to vice president Michel Temer?

Gonçalves: This will alleviate some pressure, at least in the short run. But longer term, the effects of this change are still hard to assess.

GF: How likely is it that Brazil will lose its investment-grade rating?

Gonçalves: It will depend on what the government does about fiscal consolidation. The current target, a primary surplus of 1.2% of GDP, is not convincing. The focus should be on the direction of the adjustment and its sustainability. Everybody knows how difficult–if possible–it is to scale down public spending during a recession: See the Greek case. For Brazil it will be easier because our country can correct the internal imbalances through currency devaluation and the external sector. In the end, I do not think that rating agencies will cut Brazil’s current rating, which is now BBB, two steps above investment grade. Two of the agencies have recently updated their views on Brazil and, although one changed its perspective to negative, ratings remained unchanged.

GF: As Brazil looks for ways to cut spending, the country’s development bank,BNDES,is scaling back low-cost loans in favor of more funding from project financing bonds and other tools from the private sector. The shift means less low-rate financing for the economy. What will be the impact on infrastructure building and on the GDP?

Gonçalves: The plan is not a new one. Brazil suffers from a weak capital market, and BNDES has traditionally helped fill that vacuum. The bank’s resources support privately issued debt, boosting its liquidity, a crucial aspect to attract private resources for infrastructure projects. There will be an increase in financing costs and fewer resources for the economy. The bottom line is that credit expansion in 2015 and 2016 will be much slower, and the net impact on the GDP is already factoring in the expected contraction of investments.

GF: Brazil suffers from a low level of total factor productivity. Do you see any way this can change?

Gonçalves: Productivity trends depend on a large number of factors. There’s lot to do on taxation issues, and these aspects are already part of the negotiation table. Everybody always talks of improvements in education and investments in technological research, and, of course, the two important aspects of health and sanitation. They require long-term planning. There are bottlenecks in Brazil’s infrastructure and a lot of uncertainty on how long these will stay. Last but not least, regulation risks are fewer but they remain high–an aspect that needs to be addressed by the government. For the time being, investment in the manufacturing sector is probably the only way to boost productivity in the short run, not only through the aggregation of new technology embodied in new equipment but as a consequence of the impact that manufacturing has over other activities, from transportation to procurement. I’m afraid this is not going to happen in the foreseeable future. It’s important to consider that during the latest expansion Brazil’s service sector expanded a lot, and this is a sector with a traditionally low level of productivity, which had an impact.