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Brazil – Long Road Ahead

by EOS Intelligence

Brazil – Long Road Ahead

by EOS Intelligence

by EOS Intelligence

Sentiments regarding economic recovery in Brazil rose high when Index of Economic Activity of the Central Bank (IBC-Br) recorded growth in January and February this year, only to be dampened by the March data, which showed 0.44% decline in the index. Hope of economic revival was hinged on good show by service sector, coupled with anticipation of improvement in agriculture and industrial sectors in the first quarter of 2017.

Fluctuations in IBC-Br, which is considered as a preview of Brazil’s GDP performance, indicate the fragile condition of the country’s economy, shaken by two back-to-back recessionary years. Downturn of 2015 and 2016 was uncommon in the country’s recent economic history, which had not seen the GDP declining for two straight quarters on more than four occasions since 1996. Brazil was among the few countries that were able to withstand the global financial turmoil of 2008-2009.

Reasons behind the deterioration of the Brazilian economy seem to be clear. Reliance on commodity exports for growth and high consumer debt were among the key factors that burst Brazil’s economic bubble. Unless these issues are addressed, Brazil’s long-term economic recovery will remain doubtful. Hence, it is imperative to look where the country stands with respect to each of the factors that contributed so considerably to the deterioration over the past two years.

EOS Perspective

In near term, commodities are likely to retain high share in Brazil’s external trade, as increasing the export share of finished or semi-finished goods would require significant efforts that Brazil currently is unlikely to be capable of making. Commodity prices are expected to remain volatile in near term, with soybean, sugar, and wheat likely to continue registering decline in prices (as witnessed year on year, April 2016 – April 2017). Therefore, unless the domestic demand picks up, commodity export is unlikely to assist significantly in boosting the Brazilian economy in the near future.

Keeping interest rates low is one of the ways to boost spending, and the country’s falling inflation, which in April 2017 plummeted to 4.08% (below the market forecast of 4.1%), has enabled the central bank to slash interest rates from 12.25% to 11.25%. This is expected to reduce the cost of credit for households, thereby boosting spending (amid fears of debt burden ballooning up again).

Brazil needs to create more assets to increase productivity and to create more income sources. Capital formation (a measure of investment) as a share of GDP was at about 15.5% in 2016 (fourth quarter) as compared with the high of 23% in 2013 (first quarter). The country needs to invest more, and one way to unlock funds for this would be through reforming the pension scheme (bill related to pension reforms was passed in lower house of Congress in May 2017 amid protests), which is the primary reason behind Brazil’s fiscal deficit. Brazil currently spends more than 10% of its GDP on pensions. Reforms seek to fix minimum retirement age at 65 for men and 62 for women. At present, many Brazilians qualify to retire in early to mid-fifties, and this not only impacts the productivity but also puts pressure on the government coffers.

There is a general consensus that Brazil will come out of recession in 2017, registering a modest sub-1% growth. However, to sustain this recovery, it will require a political will, fiscal discipline, and a vision for long-term growth.

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