The destiny of resources-rich Brazil

by Michael Collins, Investment Commentator at Fidelity

April 2016

Argentina and Australia were among the world’s richest countries at the start of the 20th century. The pair are far apart in the wealth rankings nowadays. Australia stands seventh in terms of GDP per capita while Argentina sits 57th; its average income is about one-fifth of Australia’s in US dollars.[1]

Argentina’s anguish is a warning for all emerging countries. In the decades before World War 1, immigration and bountiful rural produce helped enrich the South American country. It, however, all came unstuck. Sometimes problems were due to bad luck. Argentina, for instance, fell victim to the 1930s’ trade wars; in particular, to the UK decision to preference Commonwealth trading partners. Argentina’s foremost problems, though, were self-inflicted. The biggest handicap was its malfunctioning politics – exemplified by six military coups last century and policy errors during the populist Perón era from 1946 to 1955 when the economy was state directed and protectionism increased. Such troubles fostered the scourge of inequality and prevented the building of sound institutions, that, among other advantages, help minimise corruption. Australia, for all its missteps, avoided such pitfalls largely because its liberal democratic political system helped construct sound institutions, kept inequality and graft in check and steered political decisions towards the common good.

Brazil needs to learn from the histories of these two commodity-dependent countries because its political and economic crises are forcing decisions. Brazil is experiencing its worst economic malaise since the Great Depression of the 1930s. The economy is contracting at a depression-like rate because commodity export prices have collapsed and the Banco Central do Brasil has raised interest rates to the mid-teens to crush double-digit inflation. The burgeoning democracy of 202 million people is facing its gravest political crisis since the military were removed from power in 1985. A corruption scandal tied to the state oil company is entrapping the country’s political elite and threatens to ensnare President Dilma Rousseff, who faces impeachment over separate allegations her government fiddled with the country’s financial accounts.

The country, which sits just 77th on the global wealth rankings on a per capita basis but is the seventh-largest economy in the world in terms of size, confronts some tortured years. There are no quick remedies. The lesson of Australia versus Argentina is that it needs to fix its politics to heal its economy. The hopeful case for Brazil is that the crises present an opportunity to drive through vast improvements. The bigger and more encompassing the political scandals and the more senior are those entrapped, the more likely Brazil is to do just that. If Brazil entrenches its liberal democracy and builds its institutions, Brazil’s many natural endowments, from its young educated population to its vast resources, will allow the country to eventually emerge from what promise to be some tough years ahead.

These are formidable tasks and perhaps Brazil’s politics is too rotten to fix. The political crisis is so deep it’s hard to see a competent pro-business reformist government emerging soon. In fact, the scandal creates the anti-elite conditions ripe for the re-emergence of an authoritarian leader who would set back the country’s political advancements by decades. At least Brazil is not facing its traditional hyperinflation-banks-default crisis – foreigner confidence is holding, Brazil’s banks are solid, the country has adequate forex reserves, unemployment is under control and a falling currency is aiding exports. Perhaps using Argentina as a warning is unfair as the new government there has taken steps to overcome the country’s economic idleness. Maybe Australia’s recent political malaise reduces its credentials to inspire. However Argentina and Australia are faring, it’s clear that Brazil must re-engineer its politics, institutions and economy to fulfil its vast potential. Brazil’s twin crises give the country scope to do that.

Lost BRIC era

In 2001, Brazil was considered to be of such promise it was ranked as an emerging country with similar, if less grand, possibilities as China, India and Russia. The BRIC acronym was born in the middle of what was an upbeat era for Brazil.

Brazil’s economy expanded at an average annual clip of 3.4% from 1993 to 2008 as commodity prices soared, foreign investment boosted mining and manufacturing and middle-class consumption swelled. Much of the credit for these buoyant times is due to sound economic reforms known as the “stabilisation gains” of the 1990s, especially the Plano Real of 1994. The Real Plan (as it is in English) subdued Brazil’s hyperinflation that peaked at just under 2,000% in 1993, moored Brazil’s currency by pegging it to the US dollar, narrowed the current-account deficit, welcomed foreign trade and investment and reined in the state’s reach to allow private enterprise to flourish. Of significance, public institutions were bolstered and Brazil’s currency (the real) was floated in 1999, to snap decades of government exchange-rate meddling.

In the middle of Brazil’s 16 years of uninterrupted economic expansion to 2008 was a tough patch in the late 1990s when the economy barely grew.[2] The sluggish growth and the greater inequality stemming from pro-business reforms helped usher to the presidency the leader of the leftist Workers Party, Luis Inácio da Silva (2003-2011), or Lula as he is known. Lula successfully tamed the let-it-rip capitalism of his predecessor by taking advantage of the commodities boom. Helped by the rising export prices and capital inflows, filling government coffers enabled Lula to launch a credit-fuelled, consumption-led economic strategy known as Lulism that was designed to appeal to Brazilian voters. The economy responded well, averaging 4.8% annual growth from 2004 to 2008, though little was done to improve productivity, boost business investment or improve infrastructure. While much of the government’s revenue from the commodity boom was squandered, enough was directed to reduce the government-ne-debt-to-GDP ratio from 60% in 2002 to 37% six years later. Such was the improvement in Brasilia’s finances that credit raters such as Fitch Ratings and Standard & Poor’s in 2008 upgraded Brazilian government debt to “investment grade” for the first time. The better times lifted an estimated 40 million Brazilians out of poverty, boosted Brazil’s international standing, made Lula a national hero and helped Lula’s former chief of staff and protégé, Rousseff, be elected president in 2010 (when the economy expanded 7.5%). Rousseff’s central promise was that she would continue with Lula’s popular policies.

But since 2013 as mineral prices sagged, Brazil has struggled economically though not enough to prevent Rousseff’s narrow re-election in 2014. The end of the commodity boom has halved the real currency. Capital is leaving. Foreign investment has declined every year since 2011. Higher import prices have boosted inflation to 10.4%, well above the Central Bank of Brazil’s now suspended traditional target of 4.5%. To counteract rising prices, the central bank has boosted its key (Selic) rate by 700 basis points in 16 steps to 14.25%. The economy is shrinking at a 4% clip under these higher rates and unemployment has jumped to 7.6% from about 5% in 2013. The economic downturn, higher interest repayments and constitutionally mandated welfare spending are battering Brasilia’s finances and have widened the budget deficit to 10% of GDP.[3] The deterioration in public finances prompted Fitch and S&P in 2015 to downgrade Brazilian government debt to “junk” and below. Moody’s Investors Service threatens to do likewise. Plunging financial markets are adding to consumer and business angst. Price controls and a languid stimulus program have undermined confidence in the government’s ability to manage the economy. Brazil dropped 18 places to 75th in the World Economic Forum’s most recent ranking of the competitiveness of 140 countries.[4] These forces feed on each other and have put the economy into a downward spiral that could persist for years.


Politics have long been trouble-prone in what was a plantation economy built on slavery until Brazil industrialised over the 20th century. Coups, military rule and autocracy dogged a country riddled with inflation and periodic debt crises until an unsteady democracy took hold in 1985. Even today, the parliament is almost dysfunctional in the way 28 parties hold seats, so splintered is Brazil’s body politic. Corruption has always plagued Brazil, as it does any country with autocratic rulers and feeble institutions.

Today, two scandals are swirling around Rousseff. One is a corruption scandal tied to the government’s 51%-owned oil company Petroleo Brasileiro (or Petrobras), which at its height was a top-10 global company by market cap. Company executives are alleged to have colluded with subcontractors and politicians to overcharge and extract bribes from the oil giant. Much of the looted US$4 billion flowed to politicians and political parties including allegedly to Rousseff’s 2014 campaign, a charge the country’s top electoral court is investigating.

The other scandal centres on whether Rousseff’s government falsified fiscal accounts from 2012 to 2014. The government is alleged to have used accounting tricks to get state banks and other bodies to fund 57 billion reais (A$21 billion) worth of public projects, an amount worth about 1% of GDP. The federal budget watchdog, the Federal Court of Accounts, rejected the government’s books for 2014 and urged Congress not to approve them. It is these allegations that prompted the opposition to initiate impeachment proceeding against Rousseff in December.

Brazil’s political crisis intensified in March when former Workers Party senator Delcídio do Amaral, as part of a plea bargain, made sworn accusations against Rousseff for obstructing justice, and federal prosecutors questioned Lula on corruption charges tied to the Petrobras scandal. More than three million Brazilians by estimates staged protests on March 14 calling for Rousseff’s removal, a prospect that could happen now that on March 18 Congress’ lower house voted to start impeachment proceedings. As a sign of defiance, within days of the protests, Rousseff appointed Lula as her chief of staff, a cabinet-level position that gives him some legal immunity. Lula’s appointment was blocked by a federal judge, setting off a constitutional crisis on top of a political firestorm that may have reduced Rousseff’s chance of holding onto power, especially now that her coalition is splintering. In another blow to Rousseff, the process was widened in April to include Vice President Michel Temer.

The positive side to the scandals is that, rather than covering them up, the judiciary, the police and government lawyers, aided by a willing media and a disgusted public, are pursuing both cases under anti-corruption laws that Lula and Rousseff strengthened. That the president, vice president, leaders of both houses of Congress, the head of the opposition Social Democrats and an estimated 60% of lawmakers are among the political elite implicated in criminal investigations of some sort shows that no one is untouchable, as does the fact that the business elite is being jailed too.

The corruption and other inquiries and the impeachment proceedings will create Argentine-like uncertainty for a while still. At least, so far, urged on by the Brazilian middle class, the country’s democracy, rule of law, civil society and institutions are working in an Australian-like way. If that keeps up, and more capable and trustworthy leaders are found, there is hope for Brazil yet.

Financial information comes from Bloomberg unless stated otherwise.

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[1] Based on IMF figures from October 2015. GDP per capita current prices in US dollars for all the countries in database.

[2] IMF data shows Brazil’s economy expanded 0.4% in 1998 and 0.5% in 1999.

[3] The constitution of 1988 enshrines unsustainable spending that can only be overturned by an amendment passed by three-fifths of both houses of congress.

[4] World Economic Forum. “The global competitiveness report 2015-16.