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After the storm: Brazil’s economic challenges

Sahasranshu Dash and Claudio Andrés Téllez Zepeda
24 Jan 2023 00:00:00 | Update: 23 Jan 2023 23:56:56
After the storm: Brazil’s economic challenges

Barely two weeks ago, on the 8th of January, the world looked on in horror as supporters of outgoing president Jair Bolsonaro stormed Brazil’s federal government buildings. Far-right political movements the world over seem to have converged on similar tactics even in defeat. The world’s fourth largest democracy was held hostage by neo-Trumpian activists with the possible connivance of sections of the military and security forces.

However, despite the passing of this storm, Brazil’s troubled economy remains the 10th largest in the world and the largest in the Latin America and Caribbean (LAC) region. As a result, how its fortunes unfold over the course of the presidential term 2023 through 2026 will have ramifications far beyond the country’s borders.

President Luis Inácio Lula da Silva’s in-tray is truly daunting: an interest rate set by the central bank which is as high as 13.75% and high inflation amidst a global downturn. Unemployment reached a high of 14.1% in 2021Q1 and averaged 9.4% between 2016 and 2022, with a modest recovery marred by a rise in informal work and precarity in the gig economy. The percentage of young Brazilians neither working nor studying has increased from 19.4% in 2011 to 23.5% a decade later, and the number of households with a per capita income lower than 497 Brazilian reais a month (US$ 96 approx.) rose to 62.9 million people by 2021. Most alarming, especially for an agricultural export powerhouse such as Brazil, is that a little over half the population (117 million) has been confronted with some degree of food uncertainty in recent years and since early 2022, 33.1 million Brazilians face immediate hunger. There are also legacy issues pertaining to income inequality, with the income share of the top 10% of the population rising to 59.8%. Inequality is also spatial, with the northern region recording twice the national average for the poverty rate, and racial, with white workers earning 74% higher on average than Afro-Brazilians and those of mixed race. (It is interesting to observe that the electoral results leading to Bolsonaro’s defeat came, despite the administration’s best efforts, from the north-eastern region.) Structural inequities are also gendered, with the average black woman in Brazil receiving around 44.4% of the average income of white men.

The Michel Temer-era spending cap mandated that public spending could only be adjusted relative to inflation the preceding year. This effectively froze public spending in real terms for up to 20 years starting December 2016. However, the Brazilian Congress responded to Bolsonaro’s electoral defeat by approving an increase in the spending limit for one year. It raised the ceiling to R$ 145 bn (US$ 27.95 bn) and removed from the fiscal straitjacket R$23 bn (US$4.43 bn) dedicated to public investments. The intention was, in line with Lula’s campaign promises, to allow the maintenance of the Bolsa Família (phased out in December 2021 and replaced with Auxílio Brasil) payment at R$600 (US$ 115.65) and to recompose spending for the Farmácia Popular and school lunch programmes, among other expenses. Yet with public spending set to rise to 19.4% of GDP in 2023, there is an urgent need to create a new fiscal anchor to reassure markets and not allow inflation to return to the high and volatile levels of Brazil’s tumultuous past. The unconstitutional ‘secret budget’ provisions created in 2020, which Transparency International considers to be the biggest process of institutionalisation of corruption in Brazil, has to be done away with.

With high (and rising) global interest rates and liquidity drying up, there is a lot of pressure on the exchange rate. In the worst-case scenario, the trend would be upward in the country’s yield curve which would force the central bank’s hand, causing a further rise in Brazil’s benchmark interest rate, the Selic. Such rising cost of credit can damage the civil construction and automobile sectors in particular. With international raw material prices uniquely volatile since the Russian invasion of Ukraine, Brazilian agribusiness (especially in the export outlook for soybeans) is faced with significant downside risk. The forecast spread for the Harmonised Index of Consumer Prices (HICP) is also set to rise against a backdrop of policy uncertainty. Not surprisingly, forecasts for 2023 estimate Brazilian growth at or just below 1%, a significant downward revision.

With the appointment of the economist Bernard Appy to the Special Secretariat at the Ministry of Finance, the Lula government is expected to prioritise tax reform. In fact, Appy is the mentor of the current proposal in Congress, PEC 45/2019, which foresees the replacement of federal and state taxes with a single tax called IBS (Goods and Services Tax), similar to the VAT (Value Added Tax) used in several countries. Simplifying the tax code could lead to large efficiency and productivity gains for the Brazilian economy. The progressive PT government is also studying taxation of dividends over R$1 mn (US$194,600) per annum, and a reduction in payroll taxes paid by companies. Another possible avenue could be explored to address tax revenue shortfalls: revising federal subsidies and reintroducing the federal code, PIS, and Cofins taxes on fuel that had been removed in an election year by the outgoing administration. The incoming minister of economy, Fernando Haddad, has also promised a framework proposal for a new fiscal anchor by April 2023.

Privatisations such as those of Eletrobras must not be reversed. But the state-owned Petrobras, Banco do Brasil, financial services giant Caixa Econômica, and Brazil’s National Bank for Economic and Social Development (BNDES) can be re-oriented towards their social roles, instead of simply maximising profits and passing costs on to end-consumers as they did under Bolsonaro. Almost half of Brazil’s population (or 100 mn people) does not have access to a sewerage network, according to the Ministry of Regional Development. This glaring inadequacy requires increases in public infrastructure investment. Yet it is also important to keep in place the Legal Framework for Sanitation (Law 14.206 of 15 July 2020) and to deliver on its 2033 mandate.

The People’s Republic of China remains Brazil’s largest trading partner, with US$ 28 bn of trade between the two countries in 2020. However, it cannot count on China to lift the Brazilian economy’s fortunes as much as previously. Brazil’s mining exports (iron ore in particular, which formed 70% of total mining exports in 2022Q3) have been suffering from the fall in demand since China’s real estate sector slowdown began with the Evergrande crisis and the prolonged lockdowns in the pursuit of a Zero-Covid strategy. China has also pivoted from the Belt and Road Initiative, which Brazil wishes to join. After borrowers such as Venezuela and Ecuador failed to repay their loans, Beijing now pursues a more standard development assistance model centred on building basic infrastructure and securing state-owned firm oil deals. An upper-middle-income economy such as Brazil does not stand to gain much from this. In fact, overreliance on commodity exports (both mining and agricultural products) to an increasingly tech-oriented China could promote a reprimarisation and deindustrialisation of the Brazilian economy. Instead, the 2019 EU-Mercosur trade agreement, especially since President Lula’s environmental priorities, align with those of Brussels. In January 2022, the OECD has also decided to open accession discussions: Brasília must pursue this proactively.

The results of the 2022 election were celebrated around the world by environmentalists, human rights activists, and pro-democracy voices. Alongside Chile and Colombia, Brazil also ushered in a new Pink Tide of South American progressivism with possible lessons for us all. Yet as with all idealistic political revolutions, the proof of the pudding will be in economic management and actual governance.

Lula da Silva has his task cut out, and we will have to watch carefully. For now, boa sorte, Brasil!

(Sahasranshu Dash is a research associate at the South Asia Institute of Research and Development, Kathmandu, Nepal

Claudio Andrés Téllez Zepeda is a Chilean applied mathematician and political scientist with a PhD in International Relations from the Pontifical Catholic University of Rio de Janeiro. He has been living in Brazil since 1979.)

The article has been written exclusively for The Business Post