Brazil Walks A Tightrope

The coming elections hold the future of Brazil and its economy in check.

No one knows Brazil’s volatility—in economics, in politics, in society—better than Brazilians themselves. Locals often explain these ups and downs with the popular adage “Brazil is not for amateurs.”

Just three weeks before a pivotal general election, this wry cliché is being cited so often by economists and political commentators that it increasingly sounds like a motto to explain away the seemingly impossible choices facing the nation.

The coming presidential vote has two extremely polarizing candidates pitted against one another–and many Brazilians wish neither were the frontrunners for the country’s top job. The incumbent president, Jair Bolsonaro, a right-wing populist whose tenure has been marked by pro-gun, misogynistic and homophobic rants, along with support for scientifically debunked methods of containing the Covid-19 crisis, is trying to secure a second term in office.

Bolsonaro’s main adversary is the former liberal left-wing two-term populist president Luiz Inácio “Lula” da Silva. (The Brazilian Constitution limits presidential candidates to two consecutive presidential terms but doesn’t preclude candidates from future nonconsecutive runs after serving their initial two terms.) Lula is credited with reducing enormous income inequalities deeply expanding the country’s fiscal deficit. And while Brazil’s economy did well during his two terms in office—thanks to the early-2000s sustained commodity boom—his tenure was marred by deeply divisive rhetoric against the middle and upper classes, who were financing his reforms, as well as continuous corruption scandals that saw Lula land in jail and be barred from public office. He later had the entire ruling against him expunged by the Supreme Federal Court, on the basis of legal misconduct and political persecution by the chief prosecutor and his team.

Although other candidates are running, the latest polls suggest there is no stopping Bolsonaro and Lula from being the de facto two candidates left standing if no one garners the 50%-plus-one vote needed to avoid a runoff.

Optimistic Signs

Brazil’s gloom has been somewhat lifted over the past few weeks by improved economic data pouring in—though most economists treat it with extreme caution and predict a much more challenging 2023 in a globally difficult environment, irrespective of who wins the election.

Whereas earlier in 2022, Brazil was expected to grow a meager 0.8%, the country’s GDP growth has been revised up by its central bank and the International Monetary Fund to 2.5% this year. Inflation, meanwhile, is being revised down. The leading national consumer inflation index (IPCA) decreased steadily during July and August, from June’s peak of 9.25% to August’s 7.02%. The Central Bank of Brazil, in its weekly Focus market report of September 9, estimated that 2022 would end with an annual inflation rate of 6.4%.

“Such lower inflation rates do not come without consequences,” warns Nicola Tingas, chief economist of the Financial Credit Association (Acrefi). “The primary source of lower inflation forecasts comes from the government’s aggressive tax cuts on gas prices—not only at the federal level, but also by capping state taxes on fuels.”

Nonetheless, the strategy presents three problems, Tingas says. It widens the fiscal deficit, which has always been a problem in Brazil; it forces individual states into higher debt by depriving them of part of the tax they collect; and it creates uncertainty about next year, when tax cuts on fuel are due to end.

Although gas prices have been continually falling at the pump and currently stand at a national average of 4.99 Brazilian reais a liter (about $3.67/gallon), consumers have had but little respite in the price of food, which rose an average of 9.83% in 2022, or clothing, which rose 11.02%. Brazilians have seen the price of kitchen staples similarly skyrocket. At the end of July, year-on-year price increases grew by 75% for onions, 74% for strawberries, and 66% for both milk and potatoes.

This has had another adverse effect on the country’s fiscal outlook, as the government expanded its handouts and social incentive programs to various constituencies.

“This would be common in an electoral year, but the scope of welfare and the fact that the two main candidates keep promising to maintain and even expand these programs in 2023 are worrisome,” says Tingas. “We are already predicting BRL300 to BRL400 billion (about $57 billion to $76 billion) in fiscal deficits for the coming year.”

Another tool being used by the government to try to tame inflation is the continuous rise of the central bank’s interest rate, known as the Selic rate, currently standing at 13.75%. According to Patrícia Krause, chief Latin America economist at French global credit insurer Coface, the current interest rate is high, but tolerable. “A high interest rate can cap economic growth, but it is also an important tool in a volatile market with high inflationary trends and uncertainties,” she says.

Overall, this year’s trend is cautiously optimistic, as Coface upwardly revised Brazil’s credit rating to B from a previous C, even though the firm remains concerned about the country’s fiscal situation, mainly due to a worsening indebtedness of families and an increase in the government’s assistance programs.

According to Krause, Coface doesn’t see additional room for an interest hike this year and expects 2023 to end with the central bank’s Selic rate at 12%. “This isn’t to say there aren’t troubles on the horizon. We expect delinquency rates to increase in Brazil next year, even with a lower inflation rate of 5.3%. And we are currently forecasting only 0.2% GDP growth for 2023 amid more global uncertainty.”

Caution On The Path Ahead

Although the consensus points to marginal GDP growth in 2023, not all economists agree that this is a certain path.

“Many variables are changing right now across the globe and in the country that inform our perspectives. But the transition between 2.5% approximate growth in 2022 to a drop of more than 0.5% without clear perspectives for 2023 seems a bit arbitrary, despite the various economic models used to make such forecasts,” says Roberto Macedo, who currently coordinates the faculty of economics at FAC-SP and is a professor at the University of São Paulo.

“We have seen a lot of stimuli toward increased consumption during the pandemic, and that is already having some effect; the level of savings has recently decreased from its all-time high in 2020,” he says. “We have also seen a post-pandemic recovery in the services industry, but that hasn’t translated into a recovery—both in qualitative and quantitative terms—of employment.”

“We tend to talk a lot about the pandemic recession, but the fact is that Brazil has not faced a crisis. It has been in a constant depression since 2014. Even with the better-than-forecast growth this year, our GDP will still be lower than it was back then. It would take a growth rate of approximately 2% next year to put us back where we were eight years ago.

Brazil is far from the impressive growth it experienced in the 1960s, which sometimes surpassed double-digit rates. Sluggish economic output and over 20 years of hyperinflation in the 1970s led to increased poverty.

“Lula’s distributive economic policies closed some of that gap in the early 2000s at the expense of increased taxation,” says Macedo. “That was possible back then because of the sustained economic boon in commodities. Despite the recent uptick in commodity demand, all signs currently point to a very different scenario: China’s decreased growth and trade balance should mean less demand for much of Brazil’s exports.”

If he is right, 2023 could prove difficult for Brazil’s recovery as it starts a new political cycle. The national currency, the real, is undervalued by all standards, even after accounting for the strongest US dollar in over 20 years.

“The currency has absorbed the market risk associated with the widening fiscal deficit and the institutional political crisis that has plagued the country for almost eight years,” says Acrefi’s Tingas.

The devalued currency partially offset some of the pandemic woes by making Brazilian exports cheaper internationally. However, it helped increase inflation due to the higher price of imports. Worse yet, it takes away some of the incentives for modernizing Brazilian industry and infrastructure while exports grow despite a lack of competitiveness.

There’s a real danger of Brazil falling into the downward spiral that led Argentina to the terrible economic grounds where it currently stands, warns Macedo. Perpetual populist measures create unsurmountable fiscal deficits. That—along with a lack of government investment, high-interest, and a devalued currency—would not bode well for any economy.

“Argentina was one of the greatest economies of the early 20th century,” he says. “It is a cautionary tale of how ill-advised and populist measures can break a country—even a great one. What we see in the dynamics of Argentina and Brazil is that while the former constantly pursues a past that doesn’t come back, the latter keeps chasing a future that won’t materialize.”

Brazil, for the moment, seems to have found some breathing space, even amid global chaos. But unless a tight fiscal policy that doesn’t leave much room for political favors is pursued—irrespective of who wins October’s election—the country risks sliding back into stagnation and remaining far away from the promised future it wants.