Brazil’s economic prospects for 2004, and even for 2005, have been upgraded. Recently reported second quarter results showed higher growth than had been projected. Growth soared 5.7% compared with the second quarter of last year—the bottom of the recession. Compared with the previous quarter, growth was a more modest 1.5%, but even this expansion translates into a 6.0% annual rate and exceeds almost all expectations.
Has Brazil finally turned the corner? The answer is—partially, but not completely. For Brazil to experience sustained economic growth, additional changes in the areas of foreign trade, national indebtedness and savings, as well as in attitudes, will be required.
Over the last couple of years, Brazil has finally responded to the lure of the external market. Exports over the last twelve months are almost $90 billion, a dramatic increase over the annual flow of $60 billion in 2002. Highlighting this transformation has been the sale abroad of agricultural products: soy, in all of its forms, amounts to more than 10% of sales, chicken and beef are rapidly expanding, while coffee has been reduced to 1.7% of exports – a far cry from the past. Shipments of iron ore and aluminum also show rapid expansion. Manufactured products continue as the major group, accounting for more than half of exports and showing strength in the automobile sector as well as the now established category of aircraft. And, despite much comment about new markets, the United States remains the principal destination, with about one-fifth of sales, with China about to overtake a rapidly recovering Argentina at a much lower level.
Imports, too, have finally begun to respond in 2004 after remaining virtually constant for two years. The rate of growth has recently held even with that of exports, and even slightly exceeded it. Rising oil prices have led to a 66.5% increase in this category. But capital goods and primary inputs are not far behind, at a more than 40% expansion. Despite this growth, imports still amount to less than $60 billion, leaving an extraordinary trade surplus of $30 billion, which will probably get even larger by the end of the year.
There is a certain irony here. Who would have bet on the Lula administration - clearly against FTAA and with strong historical support for opponents of globalization - to produce this extraordinary result? Recall, moreover, that soy exports have been aided by adoption of bio-genetically modified seeds in Rio Grande do Sul and Paraná, again a former bête noire of the PT that now is largely accepted by the party.
Substantial growth of trade is again anticipated for 2005, and another sizable trade surplus of almost the same magnitude, more than $25 billion, has been predicted. That large surplus has more than made up for the lower level of foreign direct investment –apart from a one-off $ 4.6 billion inflow associated with a single company, Ambev.
Yet, despite such good news, a few points should be raised. First, all these numbers have been nominal, thereby ignoring the impressive gain in global commodity prices that has accompanied the rise in oil prices over the past year. Real, price-adjusted exports increased 14% in 2003, not the 26% that is commonly asserted; and in 2004, the real gain in the first half seems to be slightly larger than 18%, not the 35% that is frequently cited. Brazil, in other words, has benefited substantially from a large positive price shock.
What will be critical is Brazil’s ability to sustain the export commitment when export prices retreat, as they are likely to do over the next couple of years. Obviously the more rapidly China grows - and the less U.S. interest rates rise - the easier any Brazilian adjustment will be.
Second, there remains the question of domestic continuity. Recently, despite the impressive gains achieved, important groups within Brazil still seem unconvinced that the world market counts. Historically, a period of slow internal growth was accompanied by an increased tendency to export the surplus. Then, as domestic growth resumed, sales abroad became less interesting. Sustainable and permanent export growth of manufactured goods has not been a central part of economic strategy. Attitudes are changing, but not fast enough.
A third concern is the lack of broad Congressional support for the turn in economic strategy toward the outside world. Doubts cut across party membership because two years, however impressive, are not enough to convince everyone that permanent change has occurred. Moreover, Itamaraty, the Foreign Office, has not been inclined to advance in negotiations with the United States or the European Union, preferring to seek new gains with China, India and South Africa, as well as advances in Mercosur.
Brazil’s Level of Indebtedness
The large size of the public debt relative to gross domestic product has been a recurring concern in past years. Something like 80% of total public debt has regularly been financed internally. That makes Brazil different from many of its neighbors.
Since the Real Plan in 1994, the ratio of debt to income has ballooned by some 30 percentage points, from 27% in 1995 to more than 60% before the election of 2002. A major contributor was the large devaluation in 1999 and the continuing deterioration of the exchange rate; another was high rates of external interest provoked by international crises. Additional domestic factors in the rise of the ratio were the consolidation of the banking sector as well as federal assumption of state and local debt. On the other side, balancing these demands for resources, were the important flows emanating from privatization of state enterprises.
At the high level of public debt existing when Lula was elected, a good number of people foresaw immediate default as the only option. Otherwise, it was thought, real interest rates would remain high and domestic growth would continue to be constrained by the need of a primary fiscal surplus. Politically, that seemed unimaginable. That was a bad guess; instead came a tight monetary policy and no growth in 2003.
Now, with the economy performing better than it has since 1996, attitudes have begun to change. Forecasts call for the first decline in the net ratio of public sector debt to income in 10 years in 2004, and a substantial drop next year. The obvious consequence should be a continuing upgrade in Brazil’s rating by S&P, Moodys and other agencies—which first happened last month. Current access to external capital markets at a lesser cost is already permitting sale of securities to finance next year’s needs. Volatility is on the decline.
The continuing primary surplus, at a level beyond that achieved by the Cardoso government, has been central in avoiding deterioration of the debt-to-GDP ratio. During 2003, when growth was nil, the 4.4% surplus, along with a substantial appreciation of the exchange rate, allowed for a marginal increase in the ratio instead of the great expansion many had feared. For 2004, the decline in real interest rates has occurred at the same time as a revival of domestic growth, and the two together are pushing down the ratio to 53%. In 2005, with a continuing primary surplus and GDP growth at about 4%, the ratio should be back to around 50%. Subsequently, it should keep declining, even were the primary surplus reduced a bit.
This happy future is not without its challenges. If interest rates continue to rise in the United States, as seemingly will occur, this could induce further increases and would almost certainly set off a major political debate within the PT. A sizable group within the party, led by Minister José Dirceu, would prefer government expansion rather than contention. Finance Minister Palocci, in contrast, has so far held firm. Everyone also seems to have become comfortable in raising projections of growth for 2005, thereby quickly pushing the debt ratio down even more.
But domestic prices could increase more than anticipated if capacity utilization continues to advance. Some sectors are already approaching output ceilings, and wages are rising. It takes time for investment decisions to result in expanded production. Brazil is, therefore, at a delicate moment, where current recovery requires a major increase in domestic investment.
Brazil has managed its current recovery in growth through more intensive use of the current capital stock. There is little sign - yet - that an investment boom is about to occur. The Ministry of Development, Industry and Trade has collected data showing a 30% rise in announcements in 2004 for enlarging capacity over the next three to five years. But projected expenditures for infrastructure show up with a decline relative to the 2003 forecast. We still don’t know if a new Brazilian ‘miracle’ - when large gains in output materialized with modest increases in investment - is about to occur.
But even were such a favorable outcome to happen, the source of finance for that increase in capacity remains an issue. In the past, a major role was played by foreign savings, which allowed domestic consumption to remain high. But that was a history replete with debt – the form that such external resources primarily took. Domestic savings in Brazil are currently averaging only about 20% of GDP, and that level represents a major recent gain as a result of the current account surplus. In comparison with the rates of 30% and higher of the Asian successes, that is still too low. To get a continuous growth of about 5% a year will probably require an investment rate somewhere around 25% of GDP. Foreign resources can fill some of the gap, but on a safe basis, no more than half. That means some way must be found to increase Brazil’s contribution.
One way starts from the continuity of a large primary surplus, even if the debt-to-output ratio is in decline. A declining debt-to-output ratio will translate fairly quickly into lower real interest rates of the order of 5% rather than the current 10%. At that lower level, the transfer of interest earnings abroad diminishes substantially, and the current total government deficit equally can go down if current outlays are contained. So public sector savings can recur. But this time, instead of utilizing the resources itself, as has occurred in the past, the government can make the resources available to a private sector ready to invest.
This would represent an inversion of historical performance. Then the public sector invested, partially with its own resources, but was dependent upon inflows from the private sector. The inflation tax provided the means. Now, it is necessary for the public sector to save while the private sector, responsive to market signals and increasingly cognizant of international markets, undertakes the investment required for a growing, but non-inflationary, Brazil.
This may be a bit different from the current government emphasis on public-private partnership, a measure it is seeking to pass when Congress meets shortly. That legislation is directed at getting the government back into infrastructure investment. If the public role remains primarily one of regulation, rather than decision, the two become compatible. But this time, the public sector contribution will have to come from its own surplus, without reliance on inflation.
Brazil currently enjoys a surplus on its current account, has a primary surplus and is reducing its nominal fiscal deficit as interest rates decline. Its debt-to-income ratio is in decline. The large macroeconomic issues seem now to have become settled. There is, therefore, a sound basis for the new optimism prevalent about Brazil. Lula, and the PT more generally, now seem to have understood that political differences do not necessarily imply radically different economic models. Continuing Brazilian growth now has a real chance. But for it to become a reality, Brazil cannot rest on its laurels but instead, must make some additional difficult decisions to ensure its continued success.
*Albert Fishlow is currently professor and director of the Institute of Latin American Studies and the Center for Brazilian Studies at Columbia University, New York. Previously, Professor Fishlow was a senior fellow for international economics at the Council on Foreign Relations.